Solution manual advanced accounting 11th edition joe ben hoyle chap016

Chapter 16 - Accounting for State and Local Governments, Part I CHAPTER 16 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS, PART I Chapter Outline I State and local government units are different than for-profit entities in a number of specific ways A Governments serve a broader group of stakeholders B Most government revenues are raised through involuntary taxes C Monitoring compliance with budgeted public policy priorities is central to public accountability D Governments exist longer than for-profit businesses E The primary purpose of governments is to enhance or maintain the well-being of its citizens II State and local government units produce two complete and distinct sets of financial statements A User needs for governmental financial information are so diverse that the Governmental Accounting Standards Board (GASB) requires two sets of statements to be prepared The fund financial statements are more for the citizens whereas the government-wide statements are more for investors, such as bondholders B Fund financial statements are designed primarily to present information about the General Fund and other major activities This approach stresses the government’s fiscal accountability over its financial resources a For governmental funds, all current financial resources and claims to those financial resources are presented using modified accrual accounting for timing purposes b For proprietary funds and fiduciary funds, all economic resources are reported using accrual accounting for timing purposes C Government-wide financial statements (a statement of net assets and a statement of activities) are designed to present an overview of the government as a whole and emphasizes operational accountability a In these statements, all economic resources are measured using accrual accounting for timing purposes b The governmental funds and most of the internal service funds are combined and reported together as governmental activities c The enterprise funds and any remaining internal service funds are combined and reported as business-type activities d Because the government does not have control over the use of the assets held in the fiduciary funds, they are excluded from the government-wide financial statements III For internal purposes, governmental accounting records its individual activities within a number of self-balancing sets of accounts known as funds A Governmental funds account for activities where service to the public is the main emphasis 16-1 Chapter 16 - Accounting for State and Local Governments, Part I a General fund b Special revenue funds c Capital projects funds d Debt service funds e Permanent funds B Proprietary funds account for activities of the government where a user charge is assessed a Enterprise funds b Internal service funds C Fiduciary funds account for assets held in a trustee capacity for external parties a Investment trust funds b Private-purpose trust funds c Pension trust funds d Agency funds IV In reporting the assets (current financial resources) and liabilities (claims to current financial resources) of a governmental fund, the Fund Balance account indicates the use that can be made of these resources by government officials A Fund-Balance—Nonspendable – the amount of assets reported by a fund that cannot be spent by government officials B Fund-Balance—Restricted – the amount of assets held by a fund that must be spent in a manner designated by an external party C Fund-Balance—Committed – the amount of assets designated for a particular purpose by the highest level of decision-making authority in the government D Fund-Balance—Assigned – the amount of assets designated for a particular purpose internally but not by the highest level of decision-making authority E Fund-Balance—Unassigned – the amount of assets where no use has yet been specified This is only found in the General Fund because assets only appear in other funds if there is some intended use for them V Governmental accounting has traditionally stressed establishing control over current financial resources to ensure appropriate usage of the public’s money A Budgets are required to be approved by the citizens of the government, represented by the governing body – for example, city council, state legislature When amendments are made to the budget, the governing body has to approve them also B Budgetary entries are recorded for a number of the activities within the governmental funds a The entry is recorded at the start of the year and is then reversed to remove at the end of the year b Budget amendments may be recorded during the year C Financial commitments (such as contracts and purchase orders) are recorded during the year as encumbrances a These entries help avoid overspending of appropriated amounts b The encumbrances are removed from the records when the commitment becomes a liability 16-2 Chapter 16 - Accounting for State and Local Governments, Part I VI In government-wide financial statements, acquiring a capital asset is reported as a capital asset and incurring an expense is reported as an expense in the same manner as a forprofit business However, in reporting the governmental funds within the fund financial statements, the purchase of a capital asset, incurrence of an expense, and payment of a long-term debt are all reported as expenditures to reflect the reduction in current financial resources Through this reporting, the statements report the usage made of the resources held by the government activity A On the fund financial statements, supplies and prepaid items can be reported by either the consumption method (expenditure is recorded as item is consumed) or the purchases method (expenditure is recorded when liability is incurred) although the consumption method is required for the government-wide statements B On the government-wide financial statements, acquisitions of infrastructure items — such as bridges and sidewalks— are required to be recorded as capital assets VII Governments often have nonexchange transactions where revenues such as taxes and grants are received without a corresponding earning process To guide the timing of recognition of such transactions, four separate categories have been identified A Derived tax revenues—such as income taxes and sales taxes—are recognized when the underlying event occurs B Imposed nonexchange transactions—such as property taxes, fines, and penalties—are recognized as revenues when the resources are required to be used or in the first period when use is permitted C Government-mandated nonexchange transactions, usually a government grant to fulfill a legally required objective, are recognized when all eligibility requirements have been met D Voluntary nonexchange transactions—such as most grants and gifts—are recognized when all eligibility requirements have been met VIII Governments often raise significant amounts of financial resources by issuing long-term bonds A In the government-wide financial statements, the debt is a liability on the Statement of Net Assets B In the fund financial statements for the governmental funds, the inflow of financial resources is reported as an “other financing source.” Payment of the debt is shown as an expenditure Long-term debt balances are not shown in the fund financial statements for the governmental funds IX Transfers are separated into three categories: intra-activity transactions, interactivity transactions, and internal exchange transactions Answer to Discussion Question Is it an Asset or a Liability? Even after more than 20 years, Mautz’s comments go straight to the problem posed by government accounting State and local governments are just fundamentally different than forprofit businesses 16-3 Chapter 16 - Accounting for State and Local Governments, Part I Some students seem to believe that the unique features of government financial reporting are more arbitrary than substantive To them, accounting is accounting and the specific type of reporting entity should not be an important consideration For that reason, this discussion question is placed early in the coverage of governmental accounting to point out that governments not necessarily view transactions in the same manner as for-profit businesses Discussing the construction of a new high school building is an excellent example of the essential accounting problems created by a government’s unique perspective The decision to build this facility virtually assures the government that it will incur significant cash outflows for years to come Whereas a business constructs a building in hopes of generating net cash inflows, government officials are aware that the maintenance, heating, etc of the school will far outweigh any direct cash inflows Hence, Mautz’s question—is it an asset or a liability—is not easy to answer Governmental accounting now solves this issue in a very unique way In the fund financial statements, construction costs are reported as expenditures whereas, in the government-wide financial statements, the high school is reported as a capital asset The reduction in current financial resources is the focus on one statement whereas the cost of construction is still shown as an asset in the other set of statements Prior to class discussion, students can be asked to read Mautz’s entire article as additional background information In class, students can be encouraged to discuss whether showing this high school building in two such different ways is misleading or actually provides the information needed Students should be asked their opinion as to the benefit of having two completely different sets of financial statements A quality, in-depth discussion can certainly result from the article described here Answers to Questions Individuals and groups who seek information about a state or local government have needs that are often complex and contradictory Specific procedures in the governmental reporting process are an outgrowth of those needs GASB Concepts Statement No.1, “Objectives of Financial Reporting,” (which is now included as an appendix to GASB Codification of Governmental Accounting and Financial Reporting Standards) has identified three primary user groups: citizenry, legislative and oversight bodies, and investors and creditors The needs of these users are broad and no single set of financial statements and accounting principles can satisfy all expectations The satisfaction of diverse user needs is a constant focus (and challenge) of governmental accounting This has led to the dual-perspective model which results in the production of two distinct types of financial statements Accountability and control have been a constant goal of governmental accounting over the decades Governmental accounting provides the citizenry of a democracy with a method for evaluating the essential government actions of raising and allocating resources Elected and appointed officials have authority over the public’s money They should be held accountable for generating and using those resources wisely in meeting the public’s needs Control should be established to prevent waste and theft The accounting system should be structured to help citizens evaluate these officials based on the honesty, wisdom, and stewardship of their actions 16-4 Chapter 16 - Accounting for State and Local Governments, Part I The traditional approach of government accounting places its priority on individual accountability for the various separate government activities Unfortunately, the resulting information has not necessarily met all user needs (especially the needs of bond investors who want to know whether a government will be able to repay its debts) Today, government reporting still focuses on current financial resources in the fund financial statements (for the governmental funds), but also provides extensive additional data about all assets and all liabilities in the government-wide financial statements Thus, a broader range of user needs are met Two financial statements make up the government-wide financial statements: The Statement of Net Assets and The Statement of Activities There are a number of fund financial statements The two fundamental financial statements covered here in the current chapter were the Balance Sheet for the governmental funds and the Statement of Revenues, Expenditures, and Other Changes in Fund Balances for the governmental funds Additional fund financial statements will be introduced in the following chapter In fund accounting, governmental funds use the current resources measurement focus and the modified accrual basis for the timing of revenue and expense recognition Current financial resources include assets such as cash, receivables, and investments that can be used for spending Reported liabilities are ones to be paid from current resources The modified accrual basis recognizes revenues when they become available and measurable Expenditures are recorded when they cause a reduction in current financial resources Governments must disclose the length of time being used to determine availability A period of 60 days is common although not required except for property tax revenues Proprietary and Fiduciary funds generally use the economic resources measurement focus and the accrual basis for the timing of revenue and expense recognition The economic resources measurement focus reports all assets (including capital and other noncurrent assets) as well as all liabilities (including long-term obligations) Government-wide financial statements use the economic resources measurement focus and accrual accounting for the timing of revenue and expense recognition The accounting is very similar to that of for-profit organizations Current financial resources are primarily cash, investments, and receivables because they can be quickly turned into cash for spending purposes These resources are expected to be used to meet the current period spending needs of the governmental funds Liabilities are recognized under the current financial resources focus when a claim against current financial resources is created In many cases, that means that a debt is owed and payment will be made during the current period or a short time into the subsequent period Disclosure is required for the number of days being applied for that time extension Often, 60 days is used, a time period that is mandated for property taxes Governmental Funds: Account for activities with a service orientation a General Fund b Special Revenue Fund c Capital Projects Fund d Debt Service Fund 16-5 Chapter 16 - Accounting for State and Local Governments, Part I e Permanent Fund Proprietary Funds: Account for functions that are financed (at least in part) by user charges a Enterprise Fund b Internal Service Fund Fiduciary Funds: Account for monies held by the government in a trustee capacity a Investment Trust Fund b Private-Purpose Trust Fund c Pension Trust Fund d Agency Fund 10 The following fund types fall within the governmental funds classification: a The General Fund is used to account for ongoing activities such as public safety and sanitation More specifically, the General Fund records any activities that not fall under one of the other fund types b Special Revenue Funds account for financial resources that have been restricted as to expenditure for a specified operating purpose other than debt service and capital asset construction or acquisition This money can come from sources such as grants, taxes, and gifts c Capital Projects Funds account for monies (and their eventual expenditure) that have been designated (either externally or internally) for the acquisition or construction of government facilities or other capital assets d Debt Service Funds account for the accumulation of resources that will be used to pay the principal and interest of long-term debts incurred by the service activities e Permanent Funds account for assets conveyed to a government (often by an external donor) with the stipulation that the principal cannot be spent but any income should be used by the government, often for a designated purpose 11 The following fund types fall within the proprietary funds classification: a An Enterprise Fund accounts for any governmental activity that is open to the public and financed in whole or in part by user charges, such as a subway system or a toll road b An Internal Service Fund is used to record any activity that provides service to other departments or agencies within the government on a cost-reimbursement basis A motor pool, a centralized computer operation, or a print shop can be accounted for as Internal Service Funds if a user fee is charged and they only exist to serve the other functions of government 12 Fiduciary Funds: Account for monies held by the government in a trustee capacity a Investment Trust Fund Accounts for the outside portion of investment pools where the reporting government has accepted funds from other governments resulting in a larger investment and hopefully a higher return b Private-Purpose Trust Fund Accounts for money held in a trustee capacity, for example, unclaimed property, specifically designated external parties, or money confiscated from illegal operations c Pension Trust Fund Accounts for the employee retirement system d Agency Fund Accounts for resources held by the government as an agent for individuals, private organizations, or other government units 16-6 Chapter 16 - Accounting for State and Local Governments, Part I 13 In government-wide financial statements, financial figures are shown as either governmental activities or business-type activities All governmental funds and most internal service funds appear in the governmental acitivities All enterprise funds and any remaining internal service funds are lumped together to form the business-type activities Internal service funds are grouped in governmental activities or business-type activities based on the funds that are primarily serviced Fiduciary funds are not shown in the government-wide financial statements because the assets are not available in any way to government officials 14 In fund financial statements, for the governmental funds, a separate column must be shown for (a) the General Fund, (b) any other fund that qualifies as major, and (c) all other funds accumulated as a whole in a single column 15 Fund-balance—nonspendable – provides the balance for all current financial resources that cannot be spent by government officials Prepaid items and supplies, for example, cannot be spent by their very nature Amounts conveyed to a government where only subsequent income can be spent also fall into this category -Fund-balance—restricted – provides the balance for all current financial resources that must be used in a designated fashion as specified by a party outside of the government Amounts usually come from gifts or from grants from other organizations or governments -Fund-balance—committed – provides the balance for all current financial resources that must be used in a designated fashion as specified by the highest level of decision-making authority within the government Fund-balance—assigned – provides the balance for all current financial resources that must be used in a designated fashion as specified by individuals within the government but who are not the highest level of decision-making authority Fund-balance—unassigned – provides the balance for all current financial resources that have not been designated in some fashion Government officials are free to use these assets as they see fit 16 The physical recording of a budget is viewed as a method of disclosing public policy and financial intent, providing a financial plan for the period The budget establishes spending limitations, which enhances financial planning and control The adoption of the budget for each activity anticipates the inflow of financing resources and sets approved expenditure levels and is required to be approved by the governing body Subsequently, comparisons can be drawn between actual and budgeted figures at any time during the fiscal period, thus evaluating the performance of the government Any subsequent amendments also have to be approved by the governing body 17 Comparisons between the original budget, the final budget (as amended), and actual figures must be reported in the required supplemental information presented after the notes to the financial information in the comprehensive annual financial report Alternatively, the information can be presented as a separate statement within the government’s fund financial statements 16-7 Chapter 16 - Accounting for State and Local Governments, Part I 18 An encumbrance is the recording of a purchase commitment (such as a contract or a purchase order) The encumbrance entry is recorded at the time the commitment is made prior to incurring a liability This recording supports the spending control emphasis of the fund financial statements At any point in time, summation of the Expenditures account and the Encumbrances balance provides the total amount of current financial resources spent and committed to date Thus, the chance of an over-commitment of resources is decreased The encumbrance is removed when this commitment becomes a legal liability Until then, no transaction has taken place so encumbrances are not included in government-wide financial statements 19 Expenditures include outflows or reductions of net current financial resources from the acquisition of goods or services (or the payment of a long-term liability) Modified accrual accounting recognizes these expenditures when a claim against current financial resources is incurred that will be paid from resources that are available Fund accounting for the governmental funds records expenditures instead of expenses and capital assets as a way of disclosing the use made of a fund’s financial resources during the current period 20 Modified accrual accounting recognizes expenditures when a claim against the current financial resources is incurred that will be paid from resources that are available Governments must disclose the length of time (often 60 days) used to determine availability 21 Within the governmental funds, fund financial statements focus on expenditures rather than expenses or capital assets Expenditures should be recorded when the related liability is incurred Therefore, the entire cost of capital assets is treated as an expenditure when the liability is incurred Government-wide financial statements record capital assets in a manner similar to that used in the reporting of for-profit organizations The cost of buildings, machines, and other capital assets are capitalized and depreciated to expense over their useful lives 22 Traditionally, in government accounting, the purchases method has been used for prepaid items and supplies The cost is recorded immediately as an expenditure when the liability is incurred Any assets that remain at the end of the period are put into the records along with an offsetting increase to “Fund Balance-Nonspendable.” Another method has been developed for reporting these items and is known as the consumption method It is similar to the approach used by for-profit organizations and is used in the government-wide financial statements and by the proprietary and fiduciary funds Supplies and prepayments are recorded as assets when acquired even though they are not current financial resources Over time, as they are consumed, they are recorded as expenditures matching them with the appropriate fiscal period At the end of the period, an amount equal to the remaining assets is reclassified from fund balance-unassigned to fundbalance—nonspendable On fund financial statements for the governmental funds, either the purchases method or the consumption method can be selected 23 The four classifications of nonexchange revenues that a state or local government can recognize are: 16-8 Chapter 16 - Accounting for State and Local Governments, Part I a Derived tax revenues A tax assessment is imposed because an underlying exchange takes place The revenue is recorded at the time of the underlying event For example, revenues are recognized for a sales tax when a sale occurs and the tax is imposed b Imposed nonexchange revenues An assessment is imposed but no underlying transaction takes place Examples include property taxes and fines or penalties that are levied Revenues are recognized in the period when resources are required to be used or in the first period in which use is permitted c Government-mandated nonexchange transactions Monies are provided from one government to another to help pay for legally required programs or actions Examples include grants from the federal government to a city that must be used to help achieve a mandated legal requirement such as an improvement in the school system Revenues are recognized when all eligibility requirements have been met d Voluntary nonexchange transactions Monies conveyed willingly to a state or local government by an individual, another government, or an organization usually for a specific purpose but without legally mandated requirements Revenues are recognized when all eligibility requirements have been met An example would be money donated to the city for the beautification of the local parks 24 A receivable is not recorded for property taxes until the demand for money represents an enforceable legal claim, which is normally specified by state or local laws Many governments encourage early payment of property taxes (by sending out bills early or by giving some type of a cash discount) Thus, cash can actually be reported before the government even records the initial receivable Revenue from the property tax is reported net of estimated uncollectible amounts in the period in which the money is supposed to be used or the first period in which it can be used For example, property taxes assessed to finance the government's costs in 2013 should be reported as revenue in 2013 Because the receivable and the revenue recognition are split, it is possible to record the receivable (or cash, if collected early) before the revenue In that case, a Deferred Revenue account is established which is reclassified when revenue recognition is appropriate 25 No revenues are recognized in either set of financial statements because the proceeds of bonds must be repaid In fund financial statements, Cash is increased along with an “Other Financing Sources” figure For example, if the bonds were issued for a construction project, this entry is recorded in the Capital Project Fund Payments of both interest and debt are then recorded when they become a claim on current financial resources An Expenditure account is recognized for the debt and for the related interest and is usually shown in the Debt Service Fund In government-wide financial statements, the cash and debt are both increased when issued and the subsequent payment of debt and interest is reported in a manner similar to that of a for-profit enterprise 16-9 Chapter 16 - Accounting for State and Local Governments, Part I 26 A special assessment is an improvement made to property by a government, which is paid for in part or in whole by the owners of the property being benefited Adding curbing and sidewalks to a local street is an example of a special assessment if the residents of that street are required to pay a portion of the cost Typically, the government places a lien on the property to insure payment Accounting for special assessment projects depends on the liability for the work being incurred by the government If the government is in no way liable for the work done and any debt that is incurred, an Agency Fund is used to record the monetary inflows and outflows The government is simply serving as a conduit to get the project completed and the debt paid If the government is responsible (even secondarily responsible) for the cost of the project, a more elaborate method of accounting is necessary In the government-wide financial statements, both the debt and the infrastructure asset are recorded Amounts are assessed, reported as revenues, collected, and used to pay the debt Even if the government has liability, the infrastructure asset and long-term debt are not recorded in the fund financial statements Instead, expenditures for the work are recorded in a Capital Projects Fund while cash collected from citizens is recorded as revenue and accumulated in a Debt Service Fund to pay off any amount borrowed to finance the work 27 In fund financial statements, interfund transactions are recorded in both funds simultaneously at the time of authorization For example, monetary transfers from the General Fund to another fund such as the Debt Service Fund are recorded in both funds The recipient records this transfer as an “Other Financing Source” and the party making the transfer records an “Other Financing Use.” These balances both appear in the statement of revenues, expenditures, and other changes in fund balance but are not offset in arriving at totals for the government If the transfer is being made to a proprietary fund, it is shown in the statement of revenues, expenses, and other changes in net assets for that fund usually as a “capital contribution” or as a “transfer in.” 28 Intra-activity transactions occur totally within the governmental activities or totally within the business-type activities so that no net effect is created for that group of funds Therefore, these transfers not appear in the reporting of government-wide financial statements Interactivity transactions occur between a governmental activity and a business-type activity so that they affect the balances in each Consequently, the impact of these transactions is reported in both columns on the government-wide financial statements but are then offset so that no figure is reported in the total column 16-10 Chapter 16 - Accounting for State and Local Governments, Part I 51 (15 Minutes) (Reclassifying an activity as an enterprise fund) A Correct change is a $66,000 increase—According to the information provided, the General Fund reported an increase in its fund balance during the year of $30,000 However, the $9,000 revenue and $45,000 in expenditures were erroneously recorded in that fund Together, those transactions caused the fund to report a net reduction of $36,000 Removing these transactions (in order to record them within an enterprise fund) removes this $36,000 reduction from the General Fund and causes the increase in the fund balance to rise from $30,000 to $66,000 B Correct change is a $150,000 increase—According to the information provided, the overall increase in net assets during the year (on the government-wide financial statements) was $150,000 An error has been made in that this display was reported in the governmental activities (General Fund) rather than in the business-type activities (Enterprise Fund) That increases one column in the statement of assets (the business-type activities) and decreases the other (the governmental activities) by exactly the same amount Moving these transactions does not change the overall records for the government as a whole C Correct change is a $54,000 increase—According to the information provided, the overall change in net assets of the Enterprise Fund on the fund financial statements was a $60,000 increase However, the art display was not included as it should have been Even for fund financial statements, proprietary funds are accounted for like government-wide financial statements (and for-profit businesses) Adding in the $9,000 revenue and the $15,000 expense creates a $6,000 net reduction that drops the positive change from the previously reported $60,000 to $54,000 The acquisition of the land increases one asset and decreases another so that there is no impact on net assets 16-43 Chapter 16 - Accounting for State and Local Governments, Part I 52 (12 Minutes) (Property tax assessments) A Correct change is a $42,000 increase—According to the information provided, the increase in net assets on the government-wide financial statements was $150,000 The government, though, has recognized revenue for the amount received in the current period The amount of the assessment received is $300,000 times 40% or $120,000 However, the discount reduces that figure by $12,000 (10 percent) to $108,000 This money cannot be spent until 2014 and must be reported in 2013 as deferred revenue and not as revenue Removing this revenue reduces the overall increase in net assets by $108,000 from $150,000 to $42,000 B Correct change is a $78,000 decrease—According to the information provided, the General Fund reported an increase in its fund balance for the year of $30,000 The government, though, had recognized revenue for the amount of cash received As shown in answer A above, the amount received should have been $300,000 times 40% or $120,000 However, the discount reduces that figure by $12,000 to $108,000 This money cannot be spent until 2014 and, so, must be reported in 2013 as deferred revenue and not as revenue Removing this $108,000 revenue reduces the overall change in the fund balance from an increase of $30,000 to a decrease of $78,000 53 (12 Minutes) (Property tax assessments) A Correct change is a $42,000 increase—According to the information provided, the overall change in the net assets of the city on the government-wide financial statements was a $150,000 increase However, as shown above in 52 (part A), $108,000 was received that should have been recorded as deferred revenue until the period when it can be used (2014) Incorrectly, the city recorded the $108,000 immediately as revenue When this amount is removed, the increase in net assets drops from $150,000 to $42,000 Recognition (and the removal) of the receivable and the deferred revenue cause no change in net assets since one is an asset and the other is a liability 16-44 Chapter 16 - Accounting for State and Local Governments, Part I B Correct change is a $78,000 decrease—According to the information provided, the General Fund reported an increase in its fund balance for the year of $30,000 However, as shown above, $108,000 was received that should have been recorded as a deferred revenue until the period when it can be used (2014) The city incorrectly recorded the $108,000 as revenue When removed, the increase in net assets drops from an increase of $30,000 to a decrease of $78,000 Recognition of the receivable and the deferred revenue cause no change in net assets since one is an asset and the other a liability 54 (12 Minutes) (Recording of grant money) A Correct change is $290,000 decrease—According to the information provided, the General Fund reported an increase in its fund balance for the year of $30,000 However, $320,000 was recognized here as revenue although an eligibility requirement does remain (lowering air pollution by 25 percent) No part of this revenue can be recognized until all eligibility requirements have been met Changing the $320,000 from revenue to deferred revenue reduces the $30,000 increase in the fund balance to a $290,000 decrease B Correct change is a $170,000 decrease—According to the information provided, the change in net assets of the city on government-wide financial statements was a $150,000 increase However, $320,000 was recognized as revenue although an eligibility requirement remains (lowering air pollution by 25 percent) No revenue can be recognized until that time Changing $320,000 from revenue to deferred revenue reduces the $150,000 increase in the fund balance to a $170,000 decrease Depreciation of the machine is being handled properly 55 (8 Minutes) (Reporting of program revenues) A Correct change is a $150,000 increase—According to the preliminary information, the overall change in the net assets of the city on the government-wide financial statements was a $150,000 increase Moving revenue from general revenue to program revenue does not affect the overall change in net assets 16-45 Chapter 16 - Accounting for State and Local Governments, Part I B Correct amount of net expenses is $90,000—According to the preliminary information, the parks reported net expenses of $100,000 This net expense figure is computed as direct expenses less any program revenues The $10,000, though, should have been program revenue If this revenue had been appropriately included, net expenses would have been $90,000 rather than $100,000 Develop Your Skills Research Case No textbook is ever going to cover all of the many areas discussed within complex authoritative pronouncements The subtle nuances of such rules can only be experienced and appreciated through the study of the actual document Students needs to be aware of the extent of the official guidance that is available and gain confidence by working directly with these pronouncements Here, an issue has been raised in connection with the handling of several unusual transactions In real life, no better method of resolving such questions exists than to actually study the official standard itself A review of the GASB Codification indicates that Section 2200 covers the “Comprehensive Annual Financial Report.” Paragraphs 143 and 144 are labeled as “Special and Extraordinary Items” and paragraph 162 is also shown as “Special and Extraordinary Items.” Paragraph 141 defines extraordinary items as "transactions or other events that are both unusual in nature and infrequent in occurrence." The paragraph directs the reader to APB Opinion No 30 for further information on the exact nature of the terms "unusual in nature" and "infrequent in occurrence." Paragraph 142 defines special items as "significant transactions or other events within the control of management that are either unusual in nature or infrequent in occurrence." 16-46 Chapter 16 - Accounting for State and Local Governments, Part I Paragraph 162 indicates that special and extraordinary items “should be reported after ‘other financing sources and uses.’” The pronouncement goes on to state that “significant transactions or other events that are either unusual or infrequent but not within the control of management should be separately identified within the appropriate revenue or expenditure category.” In this case, the GASB Codification provides clear guidance as to the identity of these two accounts as well as their placement in the financial statements In practice, accountants rarely refer to textbooks when official guidelines are available Students, therefore, need to become comfortable with locating the source of authoritative information about a topic in order to become proficient at reading and understanding the material provided Research Case Here, the accountants and officials of the City of Danmark are looking for assistance in classifying a revenue as either a program revenue (reported directly with a specific activity) or a general revenue (shown for the government as a whole) A search of the GASB Codification provides extensive assistance in this case Section 2200.136 spells out that "program revenues derive directly from the program itself or from parties outside the reporting government's taxpayers or citizenry, as a whole; they reduce the net cost of the function to be financed from the government's general revenues The statement of activities should separately report three categories of program revenues: (a) charges for services, (b) program-specific operating grants and contributions, and (c) program-specific capital grants and contributions.” Examples of program revenues are then given in Section 2200.137-139 that include:  Revenue collected for garbage collection  Building permits  A state grant for the sheriff’s department to participate in a drug awareness program  Earnings on endowments if the money is restricted to a program specifically identified in the endowment agreement In contrast, general revenues are defined in the negative in Section 2200.140 as: "all revenues are general revenues unless they are required to be reported as program revenues." Thus, if any revenue does not meet the specific definition of program revenue, it is automatically labeled as general revenue Taxes are included in this category as well as any other revenues of the government that not meet the program revenue criteria 16-47 Chapter 16 - Accounting for State and Local Governments, Part I Analysis Case 1) Here is the independent auditor’s report for the financial statements Independent Auditor’s Report The Honorable Mayor and Members of the City Council City of Phoenix, Arizona We have audited the accompanying financial statements of the governmental activities, the business-type activities, the discretely presented component units, each major fund, and the aggregate remaining fund information of the City of Phoenix, Arizona (the City) as of and for the year ended June 30, 2010, which collectively comprise the City’s basic financial statements, as listed in the financial section of the table of contents These financial statements are the responsibility of the City’s management Our responsibility is to express an opinion on these financial statements based on our audit We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States Those standards require that we plan and perform that audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audit provides a reasonable basis for our opinions In our opinion, the financial statements referred to above present fairly, in all material respects, the respective financial position of the governmental activities, the business-type activities, the discretely presented component units, each major fund, and the aggregate remaining fund information of the City of Phoenix, Arizona as of June 30, 2010, and the respective changes in financial position and cash flows, where applicable, thereof and the respective budgetary comparison statements for the general fund and the major special revenue fund for the year then ended in conformity with accounting principles generally accepted in the United States of America 16-48 Chapter 16 - Accounting for State and Local Governments, Part I The management’s discussion and analysis and the schedule of funding progress included in the required supplementary information to the basic financial statements on pages through 12 and 89, respectively, are not a required part of the basic financial statements but are supplementary information required by accounting principles generally accepted in the United States of America We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the required supplementary information However, we did not audit the information and express no opinion on it Our audit was conducted for the purpose of forming opinions on the City’s basic financial statements The not-major governmental funds, other supplementary information through and including other supporting schedules, as listed in the table of contents, are presented for purposes of additional analysis and are not a required part of the basic financial statements Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated, in all material respects, in relation to the basic financial statements taken as a whole The introductory section and the statistical section have not been subjected to the auditing procedures applied in the audit of the basic financial statements and, accordingly, we express no opinion on them In accordance with Government Auditing Standards, we have also issued our report dated December 17, 2010, on our consideration of the City’s internal control over financial reporting and our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be considered in assessing the results of our audit Clifton Gunderson LLP Phoenix, Arizona December 17, 2010 16-49 Chapter 16 - Accounting for State and Local Governments, Part I Many aspects of this independent auditor’s report look very much like an audit of a for-profit business Other parts are different In an audit of a state or local government, the independent auditor's report is based on Government Auditing Standards (issued by the Comptroller General of the United States) As can be seen in this example, the report mentions the report that is available about the government's internal control procedures as well as its compliance with laws and regulations This information could be provided in the audit report or through separate reports In addition, the mention that is shown here of the supplemental information is not typically found in the audit report of a for-profit business 2) A number of items are shown in order to reconcile the net changes in fund balances for the governmental funds and the changes in net assets These typically include Internal service funds included within the Governmental Activities although they are Proprietary Funds and not Governmental Funds Recognition of expenses under accrual accounting that are not recognized under modified accrual accounting Recording of capital assets as expenditures in the fund financial statements Differences in the reporting of long-term debt issuance and payment between the government-wide financial statements and the fund financial statements 3) The largest sources of general revenues for many cities are property taxes and sales taxes However, a wide variety of revenue sources are possible 4) The amount of expenditures will vary widely based on the size of government Classifications usually include public safety, sanitation, and the like 5) The General Fund primarily shows current financial resources as its assets: cash and investments, various receivables, and amounts due from other funds Although not current financial resources, prepaid items and an inventory of supplies are also included in most cases 6) Most governments will indicate in a note to their financial statements that payables and receivables are viewed as available if collected within 60 days of the end of the year Other lengths of time, though, can be used 16-50 Chapter 16 - Accounting for State and Local Governments, Part I 7) This question focuses on interperiod equity: Is the government spending more than it takes in so that future generations may have to suffer? Or, is the government taking in more than it spends so future generations will have the benefit of an inherited surplus? Communication Case Students need to continue updating their education throughout their careers One method for doing this is to become familiar with the information available on the GASB website This assignment directs the students to look at any Current Projects being studied by the GASB for the possibility of impacting generally accepted accounting By looking at this site on a regular basis, an accountant can keep up with all issues studied by the Board as well as the authoritative evolution of accounting pronouncements as new standards are produced At the time of this writing, 11 items are listed under “Current Projects.” One of these is identified as an Exposure Draft of a new standard: “Derivative Instruments: Application of Hedge Accounting Termination Provisions.” Most of the rest are labeled as currently being deliberated By clicking on any of these, students can gain a wealth of information about the issue and potential reporting changes that may be made Students can click on any one of the “Current Projects” and read the information provided as a way to help understand the evolutionary nature of financial accounting To a student, such readings can seem tedious and difficult—at least initially However, any person who is involved actively in the financial reporting of a state or local government is probably willing to spend much time and energy in order to be aware of possible financial reporting changes and their consequences It is important to remember, though, that all of these documents may eventually be rejected outright, accepted, or may undergo either slight or radical revisions An exposure draft and an invitation to comment are certainly evidence that an authoritative pronouncement is under serious consideration but, over the decades, many proposals have gotten to these levels without the Board's being able to reach sufficient consensus to establish an authoritative principle 16-51 Chapter 16 - Accounting for State and Local Governments, Part I Communication Case Most accountants and accounting students understand that the GASB sets official standards for the accounting and financial reporting to be carried out by state and local government organizations However, probably only a very small portion of either of these groups truly knows what the established goals and mission of the GASB actually is The following information comes from the GASB website under “About GASB” and then “Mission, Vision, and Core Values.” “VISION “Greater accountability and well-informed decision making through excellence in public-sector financial reporting “MISSION “To establish and improve standards of state and local governmental accounting and financial reporting that will: -Result in useful information for users of financial reports, and -Guide and educate the public, including issuers, auditors, and users of those financial reports “The mission is accomplished through a comprehensive and independent process that encourages broad participation, objectively considers all stakeholder views, and is subject to oversight by the Financial Accounting Foundation’s Board of Trustees “CORE VALUES “INDEPENDENCE: The autonomy to pursue the best answer for all constituents, free from undue influence or pressure “INTEGRITY: Honest, ethical, and forthright behavior in relationships with all constituents “OBJECTIVITY: Impartial decisions informed by credible research and thorough deliberations, including due consideration of the views of constituents and the work of other standards setters 16-52 Chapter 16 - Accounting for State and Local Governments, Part I “TRANSPARENCY: An open process that encourages and values public participation.” Communication Case Students not always appreciate the amount of discussion, debate, and compromise that FASB and GASB usually must go through to arrive at an official accounting pronouncement Because of their inexperience, students sometimes see the creation of accounting standards as a quest for the one true and correct path: One way of accounting is right for each situation and all other ways are necessarily wrong In practice, though, many possible "right" ways usually exist as potential solutions to any accounting problem Because of the public debate created by many of these issues, the official bodies often receive numerous recommendations when any new standard is discussed and proposed The Board has to study each and then arrive at the one approach that best fits in with the members' conceptual understanding of accounting and reporting Furthermore, there are political ramifications to consider as the Board attempts to arrive at a final solution that pacifies the qualms of all the various interested parties However, the Board does help to explain its standards by presenting extensive background information This assignment is designed to give students the opportunity of looking at some of the alternatives examined by GASB prior to establishing its Statement No 34 This was the revolutionary standard that created 16-53 Chapter 16 - Accounting for State and Local Governments, Part I the dual system of reporting government financial statements Probably no other statement has had such a significant impact on the financial reporting of a state or local government The paragraphs assigned here present a number of different approaches that were suggested by members of the public and considered by the GASB In all cases, individuals who had some interest in government accounting felt that these alternatives were better solutions than the dual system of government-wide financial statements and fund financial statements mandated by GASB 34  Many respondents preferred a single set of financial statements rather than the dual approach finally chosen However, GASB found that there was no consensus that any one set of statements was preferable or provided the needed information by itself  Others simply felt that no significant change was necessary in government accounting and that the system in use at that time (very similar to the current fund financial statements) was adequate The GASB justifies its decision to move away from the previous model by stating (in paragraph 245) that "some of the information that today's users need surpasses the capabilities of the previous reporting model, particularly for governmental activities."  The suggestion was also made that fund financial statements for governmental funds not be based on measuring and reporting current financial resources Rather, each government would use the basis of accounting utilized for budgetary purposes (such as a cash system or a modified cash system) This argument held that fund financial statements are created to provide control and financial accountability which is established by the budgetary process and should, therefore, reconcile with the budget GASB rejected this idea because the wide variety of possible budgetary methods would eliminate consistency and comparability  Another solution put forth was to leave the current model as it is but make significant changes to it Basically, GASB responded that one set of statements could simply not expand to suit the wide array of user needs that had arisen over the years  Other suggestions encompassed trying to adapt the basis of accounting utilized for the governmental funds to be more useful to a wider array of financial statement users In other words, significant changes were recommended for this portion of the fund financial statements GASB indicated here that the Board felt that useful information was being provided by the previous model which focused on current financial resources and that such information should not be lost by the creation of a new model 16-54 Chapter 16 - Accounting for State and Local Governments, Part I Communication Case One of the truly significant additions to state and local government accounting resulting in recent years has been the addition of the Management’s Discussion and Analysis This written report is meant to be a discussion of the financial information reported by the government in a verbal rather than a purely quantitative fashion Students often not understand the range of information that can be uncovered within an MD&A by a careful reader Here, the student can read the MD&A for an actual city The information that is provided is quite extensive and can cover a wide range of subjects such as the following:             An explanation of fund financial statements An explanation of government-wide financial statements An explanation of governmental funds, proprietary funds, and fiduciary funds The purpose of the various funds such as the general fund and the debt service fund A comparison of the governmental activities and the business-type activities The method by which the government generates revenues The diversity of expenditures made within the governmental funds The bond rating for the government A discussion of the budgetary process Information about both capital assets and long-term liabilities The reporting of infrastructure assets that were acquired before the creation of government-wide financial statements Information about proprietary operations Excel Case Creation of this type of spreadsheet would appear to be very helpful in budget planning because city officials could plug in various increase and decrease rates and see the impact on the fund balance over time There are a number of different ways that a spreadsheet could be created to solve this particular problem Here is one possible approach: 16-55 Chapter 16 - Accounting for State and Local Governments, Part I Create Column Headings: In Cell A4, enter label text "Year" In Cell B4, enter label text "Revenue Change" In Cell C4, enter label text "Revenues" In Cell D4, enter label text "Expenditures Change" In Cell E4, enter label text "Expenditures" In Cell F4, enter label text "Ending Fund Balance" In Cell G4, enter label text "Projected Change in Revenue" In Cell H4, enter label text "Projected Change in Expenditures" Click and drag across Cells A4 to H4 Select Format, Cells, Alignment, and click the "Wrap Text" box Click OK If needed, place the cursor on the line between the Column Letters and drag the boundary on the right side of the column headings until the columns are the width you want In Cell A5, enter label text "2012" for first year In Cell C5, enter Revenues of $1,400,000 In Cell E5, enter Expenditures of $1,480,000 In Cell F5, enter beginning Fund Balance of $400,000 In Cell G5, enter -2% for Projected Change in Revenue Per Year In Cell H5, enter +3% for Projected Change in Expenditures Per Year In Cell A6, enter label text "2013." Perform Calculations: In Cell B6, enter formula to calculate Revenue Change (Revenue times Projected Revenue Change): =+C5*$G$5 Note here that adding the $ symbol to Column and Row addresses creates an "absolute" reference which will remain static throughout the spreadsheet In Cell C6, enter formula to adjust Revenues by Revenue Change: =+C5+B6 In Cell D6, enter formula to calculate Expenditures Change (Expenditures times Projected Expenditures Change): =+E5*$H$5 In Cell E6, enter formula to change Expenditures by Expenditures Change: =+E5+D6 In Cell F6, enter formula to calculate the new ending Fund Balance (initial Fund Balance plus Revenue minus Expenditures): =+F5+C6-E6 Copy formulas to adjacent rows: Click and drag across Cells A6 through F6 and release Place cursor on Fill Handle (small black box in lower right corner of selection box) and click and drag down through Row 16-56 Chapter 16 - Accounting for State and Local Governments, Part I At that point, you should see that the city will have a negative fund balance of $277,539 at the end of 2015 Simply, by changing cells G5 and H5, the impact of any different level of rate changes can be ascertained For example, if revenues decrease 5% and expenditures decrease 3% each year, changing those two cells will show that the fund balance will be a positive $14,937 at the end of 2016 Or, by assuming revenues increase by 4% and expenditures increase by 7%, the fund balance will be a negative $146,066 at the end of 2015 Any other combination of changes can be examined in the same way 16-57 ... straight to the problem posed by government accounting State and local governments are just fundamentally different than forprofit businesses 16-3 Chapter 16 - Accounting for State and Local Governments,... features of government financial reporting are more arbitrary than substantive To them, accounting is accounting and the specific type of reporting entity should not be an important consideration... financial statements and accounting principles can satisfy all expectations The satisfaction of diverse user needs is a constant focus (and challenge) of governmental accounting This has led to