Chapter 1



Chapter 1

Introduction to Accounting for

Nonbusiness Organizations

Lecture Notes

Some distinguishing characteristics of governmental and not-for-profit (NFP) entities:

• Operating purposes are other than to make a profit.

• Absence of a defined ownership interest.

• Receive significant resources from providers who do not expect

repayment or any other benefit.

• Resources are frequently restricted to a particular purpose.

• Budgets are often required and carry force of the law.

Environment of Governmental and NFP entities:

• Because of lack of market place, difficult to measure efficiency

and effectiveness in providing services.

• Resource allocation the result of a political process, with many

parties involved, resulting in many and often conflicting goals.

• Lack of continuity of leadership with new leaders and

administrators every few years.

• Actions are subject to constraints by other governmental units

and public review, resulting in focus on control and legal

compliance.

Generally Accepted Accounting Principles (GAAP)

• Encompass the conventions, rules and procedures necessary to

define accepted accounting practice at a particular time. Includes

not only broad guidelines of general application, but also detailed

practices and procedures.

• Governmental Accounting Standards Board (GASB) sets the

accounting and reporting standards for state and local

governments, as well as governmentally-related not-for-profit

(NFP) organizations, e.g., governmentally-related hospitals and

universities.

• Financial Accounting Standards Board (FASB) sets the

accounting and reporting standards for profit-seeking businesses,

as well as non-governmentally-related not-for-profits (NFP), e.g.,

for-profit hospitals and universities.

• The accounting standards of both GASB and FASB are set forth

in Statements, Interpretations, and supported by Technical

Bulletins.

• Both GASB and FASB operate under the umbrella of the

Financial Accounting Foundation (FAF).

• Federal Accounting Standards Advisory Board (FASAB) sets the

financial and reporting standards for the federal government,

with the approval of the GAO, the Department of the Treasury,

and OMB. We don't cover the federal accounting standards.

GAAP Hierachy (State and Local Governments-Ill. 1-2)

• 1st level: GASB Statements and Interpretations, plus AICPA and

FASB pronouncements made applicable by a GASB Statement or

Interpretation.

• 2th level: GASB Technical Bulletins, plus AICPA Industry Audit

and Accounting Guides and AICPA Statements of Position if

made applicable to state and local governments by the AICPA.

• 3rd level: GASB Emerging Issues Task Force consensus positions,

plus AICPA Practice Bulletins if made applicable to state and

local governments by AICPA.

• 4th level: Widely recognized industry practices and GASB “Qs

and As.”

• 5th level: Other accounting literature, e.g., Concept Statements,

AICPA Technical Practice Aids, accounting textbooks,

handbooks, and articles.

• Practitioners are required to use the higher level accounting

standards in the hierarchy, and must justify with adequate

disclosure doing otherwise.

Objectives of Federal Financial Reporting

• Budgetary integrity to demonstrate accountability of raising and

spending monies in accordance with budgets, laws, and

regulations.

• Operating performance to enable evaluation of efforts, costs, and

accomplishments of entity.

• Stewardship to enable assessment of impact on community of governmental operations and investments.

• Systems and Controls to reveal whether financial controls over the process are adequate.

Objectives of NFP Financial Reporting

• Provide information to present and potential resource providers

and other parties so they can make rational allocation decisions to

NFP organizations.

Objectives of State and Local Government Financial Reporting

• Compare actual financial results with legally adopted budget.

• Assess financial condition and results of operations.

• Assist in determining compliance with finance-related laws, rules, and regulations.

• Assist in evaluating efficiency and effectiveness.

Comprehensive Annual Financial Report (CAFR)

• Required annual report of governmental units

• Two levels of financial reporting:

• Fund-basis (5 governmental, 2 proprietary, 4 fiduciary)

• Government-wide financial statements (2)

Measurement Focus and Basis of Accounting (Ill. 1-4)

• There are three basis of Accounting:

1) Cash basis – not recorded until cash changes hands. We don’t deal with this basis separately.

2) Accrual – for exchange and exchange-like transactions, revenues are recognized in the period in which they are earned and expenses are recognized in the period in which they are incurred in earning the revenues.

3) Modified accrual – revenues are recorded in the period in which they are measurable and available, and expenditures are recognized as the goods or services are received or a liability incurred.

Revenues are measurable when stated in terms of dollars, and

available when collectible in current period. Expenditure

accounting follows normal accrual accounting with some

major exceptions, e.g., liabilities that are not paid until well

into the future are not recognized as expenditures until the

liability is funded. Governmental accounting uses the term

expenditures instead of expenses, since they represent more the

use of funds than the expiration of assets.

• There are two measurement focuses:

1) Spending focus or current financial resources measurement focus. Focus is on current, spendable resources. Neither long-term assets or long-term liabilities are recognized.

2) Capital maintenance focus or economic resources measurement focus. Focus is on the ability to maintain capital over time and is concerned with the proper matching of revenues earned with costs incurred in evaluating the entity’s performance. As a result, entities using this focus include both long-term assets and long-term liabilities.

Governmental Funds

• Five types of governmental funds are used to account for most of

the activities of local and state governments.

• Since a spending or current financial resources focus is used by governmental funds, and the concern is with current assets, their use and availability, expenses are called expenditures for these governmental entities. Rather than being based upon a matching process, it more measures the use (expenditure) of assets. Also, the balance in Fund Balance is suppose to represent available, spendable resources, rather than equity ownership as with a business enterprise. Has no long-term assets or liabilities!

1) General Fund

Accounts for the general operation of the government and other

activities not accounted for in any other fund. Other governmental funds are specialized for a particular purpose.

Focus is on spending

Uses modified accrual basis of accounting

There is only one General Fund in a governmental entity

2) Special Revenue funds

Accounts for resources legally designated for a particular purpose

that must be separately reported (e.g., gasoline sales taxes can

only be spent for highways and roads)

Focus is on spending

Uses modified accrual basis of accounting

Accounting treatment is the same as for general fund, just a more

limited breath of activities

Should only be used when required by law, charter, or commitment

Can have several Special Revenue funds since law frequently

requires separate accounting

3) Capital Projects funds

Accounts for resources dedicated to the acquisition or construction

of major capital facilities

Focus is on spending

Modified accrual basis of accounting

Used if there is a legal requirement or when issue bonds and other

restricted sources of revenues

Usually one for each project

4) Debt Service funds

Accounts for resources dedicated to pay principal and interest on

general obligation debt.

Focus is on spending

Modified accrual basis of accounting

Revenues are sources of funds to pay debt

Expenditures are payments on principal and interest

Fund balances are those resources available to service the debt

Liabilities for principal that are not currently due are not

included (long-term liabilities are included in government-wide

financial statements under full accrual accounting)

May have one or several debt service funds.

5) Permanent funds

Accounts for resources held in a fiduciary or agent capacity, but

usable only for governmental purposes.

Are used to account for resources that are legally restricted to the

extent that earnings – but not principal – are to be used for

purposes that support the reporting government’s programs. An

example is a cemetery perpetual-care fund, which generates

resources to maintain a public cemetery.

Proprietary Funds

• Two types of proprietary funds. Used to account for governmental organizations that are suppose to operate like a for-profit business, e.g., municipal airport.

1) Enterprise funds

Accounts for resources used to supply goods or services to

individuals and organizations outside the governmental unit (e.g.,

general public). GASB 34 broadens the definition of Enterprise

Funds somewhat by making it clear that these funds are to be

used for any activity financed with debt that is secured solely by

net revenue from fees and charges to external users.

Capital maintenance focus; cost of providing the service is

supported by user fees

Full-accrual accounting

Usually a separate fund is established for each activity

2) Internal Service funds

Accounts for resources used to supply goods or services within the

government unit or to other governmental units on user charge

basis

Capital maintenance focus

Uses full accrual accounting to reflect the total cost of service

Fiduciary Funds

• Four types of fiduciary funds. Are used for resources held in a fiduciary or agent capacity for others outside the government (e.g., individuals, private organizations, and other governments). Since Fiduciary funds cannot be used to support programs of the reporting government, fiduciary funds are excluded from the government-wide financial statements.

Full accrual accounting and capital maintenance approach is used by them.

1) Agency funds

Accounts for resources held by the government that must be

distributed according to law or contractual agreement, e.g.,

property taxes or payroll taxes.

2) Pension Trust fund

Used to account for resources held by the government and used

to finance employee’s pension plans

3) Investment Trust funds

Accounts for investment funds of other governmental units

being held by the government as a sponsoring organization.

4) Private-purpose Trust fund

Accounts for trust arrangements where the principal and

interest of the trust benefit outside individuals, private

organizations, and other governments.

Budgetary Accounting

• GASB standards require that an annual budget be adopted by

every governmental unit.

• The accounting system should provide appropriate budgetary control.

• Budgetary comparisons should be included in financial statements and schedules where an annual budget has been adopted.

Accounting for Capital Assets

• The two government-wide financial statements (Statement of Net Assets, Statement of Activities) are required to account for capital assets at historical cost, with donated assets recorded at fair value. Capital assets include land, buildings, equipment and other assets with long-term life.

• All capitalized assets are to be capitalized and depreciated over estimated useful lives, which depreciation is to flow through the government-wide financial statements. The two proprietary funds also capitalize assets and depreciate them over their useful lives.

• An exception is infrastructure assets, which are always required to be capitalized, but governments may choose not to depreciate them if certain conditions are met, in which case the modified approach can be used. The conditions are: 1) an asset management structure system must be set up, 2) the government has to keep an inventory, and 3) documentation is required that the condition of the assets has been preserved at (or above) the established level. Condition assessments evaluating whether these conditions have been met are to be conducted every three years.

• A second exception are works of art and historical treasures that are part of a collection. Under certain conditions they are not required to be either capitalized or depreciated. Collections must be 1) held for public exhibition, 2) cared for and preserved, and 3) proceeds from sales used to acquire other items for collections. When a collection is not capitalized, then there should be a description of the collection in the financial statements and the reasons why it was not capitalized. If works of are capitalized, then normally they are not depreciated since they have an indefinite life. If they are considered to have a limited life, then they should be depreciated.

Accounting for Long-Term Liabilities

• Long-term liabilities are not accounted for in the governmental funds. Instead are reported in the government-wide financial statements (Statement of Net Assets), which accounts for debts to be paid out of general governmental resources (e.g., general obligation debts).

• The two proprietary funds, in contrast, do account for their long-term debts, since they use full accrual accounting, which long-term debt is also included in the government-wide financial statements.

Conversion Process to Government-Wide Financial Statements

• Illustration 1-3 provides an overview of the conversion process of the governmental, proprietary, and fiduciary funds to the two government-wide financial statements. This process is discussed more extensively in Chapter 8 and it is useful for you to review Ill. 1-3 at that time.

• First, fiduciary funds statements are not incorporated into the government-wide financial statements, but are shown separately toward the end of the CAFR.

• Second, proprietary funds are already full accrual so don’t have to be converted, but the internal service fund is combined with the five governmental funds into governmental activities, while the enterprise fund is shown as business activities in the these financial statements.

• Three, the five governmental funds are converted from modified accrual accounting to full accrual accounting and then combined with the internal service funds as governmental activities in the two government-wide financial statements. Note that since the modified accrual method used by the five governmental funds does not recognize either long-term assets or long-term liabilities, they have to be kept up with and later added in adjusting them to full-accrual accounting. Revenue and expense items recognized using the modified accrual method also have to be converted to full accrual accounting.

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