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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