Accounting and Financial Reporting Study Guide

Government Finance Officers Association of Texas

Certified Government Finance Officer Program Study Guide

For Accounting and Financial Reporting Revised February 2017 John J. DeBurro, CPA Originally Developed by

Center for Public Management

University of North Texas

Accounting and Financial Reporting Study Guide

Table of Contents: Introduction ....... .......................................................................................... 1 Funds: The Building Blocks of the Governmental Accounting System .......6 Interfund Activities ..................................... .....................................12 Accounts: The Building Blocks of Funds. .................................................... 13 Recording and Reconciling Transactions.......................................... 17 Measurement Focus ......................................................................................22 Financial Reporting ...................................................................................... 26 Other Topics ................................................................................................ 34 Recent GASB Statements. ........................................................................... 37 Additional Sources ....................................................................................... 38 Endnotes ....................................................................................................... 38

Accounting and Financial Reporting Study Guide

(Revised February 2017)

Whereas the operating and capital budgets represent the legislatively-sanctioned plans for spending and expected revenues needed to meet those outlays, the accounting system provides the record keeping framework in which to record (in journals) the transactions authorized by the budget and to reconcile (in ledgers) their cumulative financial impact. In both public and private organizations, the two most important financial documents are the budget and annual financial report. And in both, the accounting system links the two together by providing the framework for processing financial transactions.

operating and capital

accounting

comprehensive annual

budgets

system financial report

Figure 1. The centrality of the accounting system

In business the financial report is the more important of the two documents given its role in informing investors of the profitability of the firm. In government the budget is the more important since it defines a government's scope and level of activity. The budget provides a basis of accountability at the policy (values), programmatic (outcomes), and performance (efficiency) levels.1 The accounting and financial reporting system are best suited to providing accountability at the process (flow of resources) and compliance (comparison of budget with actual) levels.

Whereas accountability is the cornerstone of financial controls, the accounting system seeks to provide financial information that is understandable, reliable, relevant, comparable, consistent, and timely.2 These six goals of accounting also form the conceptual basis for the standards -- called generally accepted accounting principles (GAAP) -- adopted by the accounting profession that guide the recording, reconciling, and reporting of transactions in the accounting system. As a result of GAAP's general acceptance among state and local governments, the recording and reporting of accounting information is much more standardized than is the case of budget information.

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The Governmental Accounting Standards Board (GASB), the seven-person body of accounting professionals, is the primary source of such standards, interpretations, and technical bulletins for state and local governments. Since GASB's creation in 1984, considerable discussion has ensued concerning GAAP, particularly those concerned with the basis of accounting and the treatment of fixed assets and long-term debt. In June 1999, GASB adopted Statement No. 34, "Basic Financial Statements ? and Management's Discussion and Analysis ? for State and Local Governments,"3 which introduced sweeping changes to the structure of the basic financial statements for state and local governments and the way in which accounting information is recorded and reconciled. These changes are discussed throughout this chapter. The table on page 5 summarizes the 13 basic accounting principles that apply to state and local governments.

One benefit of standardizing the accounting system is that comparisons can be made across governments and conclusions drawn on the relative financial health of each. Another benefit is that users can interpret financial reports more easily. The most important benefit, however, comes in assuring users that a common set of rules is being applied to reporting the results of financial operations. An external auditor can more easily verify the accuracy of a financial report if it has been prepared on the basis of GAAP. The widespread acceptance of GAAP also fulfills the accounting profession's goals for accuracy, reliability, and consistency in reporting the results of operations.

However, the GAAP adopted for use by government differs considerably from that used in the private sector. For example, whereas a business combines the results of the operations of all its subsidiaries into one consolidated report, governments report their results by groups of funds (the accounting entity). A fund is a fiscal and accounting entity with a self-balancing set of accounts,4 meaning that each fund functions like a self- contained business with its own set of accounts and financial report. As a result, many transactions occur just between funds.

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Principle #1. Requires that accounts be maintained on a GAAP basis and demonstrate compliance with finance-related legal requirements.

Principle #2. Specifies that funds must be the basis for maintaining accounting records.

Principle #3. Identifies and defines the eleven basic types of funds used in governmental accounting.

Principle #4. Governments should maintain a minimum number of funds and only those required by law.

Principle #5. A distinction should be maintained in the accounting records among the capital assets of proprietary funds, fiduciary funds, and those of governmental funds.

Principle #6. The historical cost of capital assets (land, buildings, equipment, infrastructure) and long-term debt should be maintained in the accounting records.

Principle #7. Depreciation of capital assets should be recorded in the accounting records.

Principle #8. The accounting records should maintain a clear distinction between longterm liabilities attributable to a specific fund and those to the general government.

Principle #9. The accrual basis of accounting should be used for the government-wide financial statements. The fund-specific financial statements should use the modified accrual basis for governmental funds and the accrual basis for proprietary and fiduciary funds.

Principle #10. An annual budget should be adopted, budgetary control is provided by the accounting system, and an annual comparison of budget with actual results of operations should be made.

Principle #11. Interfund transfers must be recognized and reported depending on whether the transfer involves reciprocity or not.

Principle #12. A common terminology and classification system should be used throughout all financial records.

Principle #13. Interim financial reports should be prepared and the format of the comprehensive annual financial report (CAFR) should follow a specified format.

Table 1. The 13 generally accepted accounting principles. Source: Robert J. Freeman and Craig D. Shoulders, Governmental and Nonprofit Accounting. Upper Saddle River, NJ: Prentice Hall Publishers, Inc., 2003: pp. 33-54.

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The segregation of accounts into funds has led to different methods of recognizing accounting transactions, depending on the type of fund. Whereas in the private sector only the accrual method of accounting is used, in government the modified accrual method is used for certain types of funds. The use of separate funds combined with these differential bases of accounting make governmental accounting much more complex than its counterpart in the private-sector. This complexity reflects the public sector's obligation to provide accountability to various stakeholders ? citizens, city councils, and investors in bonds and other creditors such as banks ? with their particular information needs.

This section summarizes the accounting cycle and how financial information is entered into that system. It also provides an introduction to the elements of fund accounting and the role of budgetary accounts in that system. It concludes with a brief introduction to double-entry record keeping and the accrual basis, the hallmarks of contemporary accounting practice.

Funds: The Building Blocks of the Governmental Accounting System

The use of funds by governments initially emerged as a budgetary innovation and was adapted by the governmental accounting system as it evolved in the early part of the 20th century.5 Although some in the accounting profession have called for the elimination of funds, they have become so institutionalized that GASB accepts them as part of the accounting framework.

Although a fund is formally defined as a fiscal entity with a set of self-balancing accounts, conceptually a fund may be viewed as a legal entity that receives inflows and incurs outflows of financial resources. If the inflows exceed the outflows, the fund accumulates a balance; conversely a net outflow results in a reduction in fund balance. Each fund contains the same basic types of accounts, described in the following section, but receives revenue from different sources. Funds are almost always created by law or by executive fiat. A government may have anywhere from less than 10 to several hundred funds.

Table 2 identifies the eleven basic types of funds specified by GAAP for governmental

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budgets and accounting records and the three broad categories in which they are grouped governmental, proprietary, and fiduciary. The primary operating fund, the General Fund, is usually the largest and most important in terms of the operating budget. It is "general" because it "should be used to account for and report all financial resources not accounted for and reported in another fund". [GASBS 54, ?29]. In most cases, governments will refer to it as the General Fund in their budget and financial reports, although the state of Texas, for example, refers to it as the General Revenue Fund.

Governmental Funds: 1. General Fund 2. Special Revenue 3. Debt Service Funds 4. Capital Projects Funds 5. Permanent funds

Proprietary (Business-type) Funds: 6. Enterprise Funds 7. Internal Service Funds

Fiduciary Funds:

8. Investment Trust Funds 9. Private-purpose Trust Funds 10. Pension Trust Funds 11. Agency Funds

Examples: General Fund Hotel/Motel Tax Fund 2016 Series Debt Service Fund Eagle Street Improvement Fund Oaklawn Cemetery Perpetual Care Fund

Water/Wastewater Fund Motor Vehicle Pool Fund

Countywide Cash Investment Fund Employees' Tuition Savings Fund Municipal Employees Retirement Fund Local Sales Tax Fund

Table 2. The eleven basic fund types

Whereas a city government has only one General Fund, it may have several special revenue funds, each with a particular name, such as the Hotel/Motel Tax Fund. Such funds are established to account for the proceeds of specific revenue sources that have been committed or restricted to expenditure for specified purposes other than debt service or capital projects [GASBS 54, ?30]. For example, a state or local hotel/motel occupancy tax may be restricted to use in promoting tourism, historic preservation, and economic development. Often, local governments account for grants received, which are restricted for particular purposes, in special revenue funds. These funds enable governments to segregate revenue that may have restricted uses from that used for general operations and provide a means for verifying that it was used for purposes specified in law. For most special revenue funds, the operating budget will provide the authorization on the use of funds.

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A third type of governmental fund is the debt service funds. Local governments may have one or more such funds depending on their accounting preferences. Debt service funds account for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest [GASBS 54, ?34] of long-term, general debt, such as the annual debt service required on a general obligation (GO) bond. Sometimes, governments establish a separate fund for each GO bond series. Years ago, they were called "sinking funds" in reference to the process of sinking (retiring) a debt obligation. Local governments, when adopting a property tax rate, typically levy two distinct rates ? one for general operations (the M&O rate), which is accounted for in the General Fund, and one or more rates for debt service (the I&S rate), which are deposited in the appropriate debt service fund. (See the sample tax rate ordinance in Figure 2 on the following page.) The annual operating budget will also provide the authorization for the use of resources from these funds.

The fourth type of governmental fund ? capital projects funds ? account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays, including the acquisition or construction of capital facilities and other capital assets [GASBS 54, ?33]. For example, a city council may choose to create a separate fund ? Eagle Street Improvement Fund ? for the reconstruction of this thoroughfare. Revenues flowing into the fund may include GO bond proceeds that were authorized for the project, state and federal grants, and intergovernmental revenue. The outflow of the fund, called expenditures or the value of goods and services delivered, are typically for the services of contractors for the design and construction phases of the project. Once the project is complete, the fund may be closed out and the remaining balance transferred to other capital project funds or to a committed or restricted account in the General Fund. Authorization for the resources and expenditures of these funds originates with the capital budget, which provides detail on each project's sources and uses of funding.

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