Chap003 (2)

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Essentials of Accounting for

Governmental andNot-for-Profit Organizations

Chapter 3

Modified Accrual Accounting:Including the Role of Fund Balances and

Budgetary Authority

McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights re

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Overview of Chapter 3

The basic accounts used by governmentalfunds.

Recognition criteria for revenues andexpenditures under the modified accrualbasis.

Fund balance classifications forgovernmental funds.

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Modified Accrual Accounting

The modified accrual basis is a distinctsystem of accounting that contains financial

statement elements that appear nowhereelse.

Among these are expenditures and fundbalances.

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Modified Accrual Accounting

Although, revenues appear in the financialstatements of accrual and modified accrual

funds, revenues follow different recognitioncriteria between the two bases.

Finally, there are no expenses in modifiedaccrual funds

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Account Structure Permanent AccountsAccounts that are not closed at year end

(Balance Sheet)

Assets:Cash and Cash Equivalents

InvestmentsReceivables: -

Taxes ReceivableAccounts ReceivableDue from Other Governments

Supplies Inventories

Restricted Assets (typically cash)

Liabilities:Accounts Payable

Accrued LiabilitiesDeferred Revenues

Fund Balances:NonspendableRestrictedCommitted

AssignedUnassigned

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Account Structure - Nominal AccountsAccounts that are closed at year end

Budgetary Accounts

Financial Statement Activity Accounts

Estimated RevenuesAppropriations

Estimated Other Financing SourcesEstimated Other Financing UsesEncumbrances

RevenuesTax Revenues

Charges for ServicesExpenditures Current

Capital OutlayDebt Service

Other Financing Sources

Transfers InDebt Proceeds

Other Financing Uses Transfers Out

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Assets and Liabilities

Modified Accrual Funds use the CurrentFinancial Resources Measurement Focus

Generally speaking, the assets represent cashand assets that may be expected to be convertedinto cash in the normal course of operations. (nolong-term assets)

Similarly, these funds report only those liabilitieswhich will be settled with current financialresources. (no long-term liabilities)

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Fund Balance - interpretation

Since only current financial resources and claims againstthose resources are recognized in these funds, thedifference between assets and liabilities (fund balance)

represents the net resources of the fund that are currentlyavailable for future spending.

However, even current financial resources vary in theextent to which government managers have discretion

over their future use and this is reflected by assigningfund balance to five categories (nonspendable, restricted,committed, assigned and unassigned).

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The objective of Statement No. 54 is toprovide clearer fund balance classifications.

Users want to know whether the use of amountsreported in governmental funds is constrained andhow binding those constraints are.

GASB 54 Establishes theReporting of Fund Balances

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Statement No. 54 affects only fund-basisstatements of the Governmental Type

funds Does not affect reporting of Net Assets by Proprietary

or Fiduciary Funds

Does not affect reporting of Net Assets ofGovernmental Activities in the government-widestatements.

GASB 54 Fund BalancesFinancial Statements

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Fund balances of governmental type funds

are reported within 5 categories Nonspendable

Restricted

Committed

Assigned

Unassigned

GASB 54 Fund BalancesSummary

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Two Step Process Step 1:

Identify those fund resources that are

Nonspendable Nonspendable resources include:

Inventories and prepaids (also incudes assets held for sale andlong-term receivables)

The principal (corpus) of a Permanent Fund

Two Step ProcessStep 1: Nonspendable resources

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Step 2: Spendable Resources

All remaining net resources of a fund after

removing those determined to beNonspendable

- Spendable resources are further classified

according to the nature of any constraintsimposed on their use, using a hierarchy ofconstraints

Two Step ProcessStep 2: Spendable resources

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Restricted Funds

Committed Funds

Assigned Funds

Unassigned Funds

GASB 54 Fund BalancesConstraint Heirarchy

No Constraint

Most constrained

(General Fund)

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RestrictedRestricted : Constraints placed on the useof resources are: Externally Imposed (debt covenant, grantor,

contributors, or other governments)

Imposed by law (constitutionally or enablinglegislation)

i.e. enforceable requirement that resources be

used only for specified purposes

Constraint Hierarchy:Restricted FundsRestricted Funds

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In general, the definition of restricted fund balanceis nearly identical to that of restricted net assets in theGovernment-wide Statements Exception is Permanent Fund Principle which is classified as

Nonspendable in the governmental funds

Constraint Hierarchy:Restricted FundsRestricted Funds

Government -WideStatement of Net Assets

Fund-BasisGovernmental

Funds Balance Sheet

Net assets restricted $ xxx Restricted fund balance $ xxx

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Committed:Committed: Constraints placed on theuse of resources by:

The formal action of the governments highest level of

decision making authority.

GASB 54 specifically identifiesContractual Obligations as one form ofcommitted resources

Constraint Hierarchy:Committed FundsCommitted Funds

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Statement 54 also provides guidance on the classification ofbudgetstabilization orrainy dayfunds Such stabilization amounts that meetcertain criteria are classified as committed or (less commonly)restricted, if imposed externally or by law.

Rainy day funds are classified as committed only if they are created bya resolution or ordinance that identifies the specific circumstancesunder which the resources may be expended. Rainy day amounts that are available in emergencies or in periods of revenue

shortfalls would not be classified as committed unless the emergency or shortfallcondition is specified and of a magnitude to distinguish it from events that occurroutinely.

Rainy day funds not meeting these conditions are reported as unassigned fundbalance in the General Fund.

Constraint Hierarchy:Rainy Day FundsRainy Day Funds

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AssignedAssigned: The government has anexpressed intent to use resources forspecific purpose:

For governmental funds other than the General Fund,this is the category for all remaining (positive) amounts.

For the General Fund, assignment conveys a narrowerintended use than the general purposes of thegovernment

Constraint Hierarchy:Assigned FundsAssigned Funds

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Unassigned:Unassigned: Residual classification ofthe General Fund

Only the General Fund can report a positive unassignedfund balance

For other governmental funds this is used only for anegative fund balance (in any of the previous 3 constraint

categories)

Constraint Hierarchy:Unassigned FundsUnassigned Funds

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Classification: Step 1 CITYBalance Sheet

Governmental Funds

As of December 31, 2009

General SpecialRevenue Capital Projects Debt Service Permanent

ASSETS Fund Fund Fund Fund Fund

Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366

Investments 3,312,992

Receivables (net)

Taxes receivable 2,872,611

Accounts Receivable 679,215 14,177

Due from Other Governments 1,085,184 243,264

Supplies Inventory 23,747

Restricted Assets 3,933,126

TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366

Are there assetsnot in spendable

form? e.g.Inventory &prepaids

Required tomaintain

permanent fundcorpus?

No

Proceed tospendablecategories

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Classification: Step 1 CITY

Balance Sheet

Governmental Funds


General SpecialRevenue

Capital Projects Debt Service Permanent

ASSETS Fund Fund Fund Fund Fu

Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366Investments 3,312,992

Receivables (net)






TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366

LIABILITIES

Assume the permanent fundcorpus is $ 25,000.

yes

Assets not inspendable form?

Inventory &prepaids

Required tomaintain

permanent fundcorpus?

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Classification:Step 2a (Restricted Funds)

Are restrictionsimposed by outsidecreditors, grants, or

imposed by law?

Assume the following: Bond sinking fund Federal school lunch grant State highway grant

yes

CITY

Balance Sheet

Governmental Funds


General Special Revenue Capital Projects Debt Service Permanent

ASSETS Fund Fund Fund Fund



Receivables (net)






TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366

LIABILITIES

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Classification:Step 2b (Committed Funds)

Has city councilformally committed

funds to specificactivities?

Assume the following: Construction contracts School construction funds Rainy day reserve

yes

CITY

Balance Sheet

Governmental Funds






Receivables (net)






TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366

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Classification:Step 2c (Assigned Funds)

Are there positiveresidual balances

in non-General FundGovernmental funds? yes

CITY

Balance Sheet

Governmental Funds






Receivables (net)






TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366

LIABILITIES

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Classification:Step 2c (Assigned Funds)

Are there specificresources in the

General Fund that areintended for identified

purposes?

yes

Assume the government hasoutstanding encumbrances forthe following: Library acquisitions

Other capital projects

CITY

Balance Sheet

Governmental Funds






Receivables (net)






TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366

LIABILITIES

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Classification:Step 2d (Unassigned Funds)All negative restricted,committed, or assigned

net resources areclassified asUnassigned.

The remaining netresources of the

GeneralFund are classified as

Unassigned

CITY

Balance Sheet

Governmental Funds



ASSETS Fund Fund Fund Fund Fun



Receivables (net)






TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366

LIABILITIES

Accounts payable 2,085,358 70,000 207,134

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Classification CompletedGeneral Special

RevenueCapital

ProjectsDebt Service Permanent

FUND BALANCES Fund Fund Fund Fund Fund

Nonspendable


Permanent fund principal 25,000

Restricted

Bond Sinking Fund 200,000

School lunch grant 370,000

Highway grant 302,000

Committed

Construction Contracts 120,000

School construction 450,000

Rainy Day Funds 3,500,000

Assigned

School lunch program 202,014

Ca ital ro ects 95 000 40 032

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GASB 54 Fund BalancesEncumbrances Encumbrances

Under past reporting practices, outstanding encumbrances at yearend were reported in the governmental funds as fund balance:reserve for encumbrances. Statement 54 requires that significant encumbrances be disclosed in the notes

along with required disclosures about other commitments.

However, there is no separate reporting of encumbrances withinthe fund balance section of the governmental funds balance sheet.

Rather, encumbered resources should be reported within the restricted,committed or assigned categories in a manner consistent with the criteria forthose classifications.

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GASB 54 Fund BalancesEncumbrances

Encumbrances Interpretation At the very least, the existence of an encumbrance suggests that the

government has an expressed intent to use resources for a particular purpose

and therefore these resources should not be classified as unassigned.

Encumbrance accounting may also be used in the case of contractualobligations, such as construction contracts. Statement 54 requires thatresources obligated to contractual obligations be classified as committed.

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GASB 54 Fund BalancesNegative balances

Negative Balances Statement 54 does not permit the reporting ofnegative

restricted, committed or assigned fund balances. If this occurs,

the government should reduce any assigned fund balances (inthat fund) by the amount of the negative balance. The rationale is that if expenditures exceed restricted or

committed resources, then funds have in effect beenreallocated to the purpose used.

If a deficit remains once all assigned fund balances are zero,the remaining negative amount should be reported asunassigned fund balance.

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Activity Accounts Sources of funds

Other Financing Sources include transfers infrom other funds and the proceeds of long-termborrowing.

Revenues are defined as all other inflows andinclude taxes, charges for services, andamounts provided by other entities such as the

state or federal government.

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Activity Accounts Uses of funds

Expenditures are recognized when a liability isincurred that will be settled with current financialresources in the fund. Expenditures may be for

salaries (current), land, buildings or equipment(capital) or for payment of interest and principalon debt (debt service).

Transfers out of a fund to other funds areclassified as Other Financing Uses.

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Classification of Inflows andOutflows on Budget Schedule

Revenues are classified by source Where the money came from: taxes, licenses and

permits, charges for service, etc

May be subdivided further such as by type of tax,sometimes shown in separate schedule

Expenditures and Encumbrances may beclassified by function, program, department, activity, character, or

object

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Outflow Classifications

Character groupings are always: CURRENT,CAPITAL OUTLAY, and DEBT SERVICE

Current are typically classified by function:General government, public safety, streets and highways

Public safety could be subdivided by department: Policeand fire Police could be subdivided further by activity: Traffic and

drug enforcement Activities in the traffic area could be divided into objects ofexpenditure: Policemans salary, gas for automobiles

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Budgetary Accounting

GASB standards require governments to present acomparison of budgeted and actual results for theGeneral Fund and special revenue funds with legally

adopted budgets. While GASB standards guide the format of this

comparison, the GASB does not prescribe budgetaryaccounting practices and does not require governmentsto maintain budgetary accounts.

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Recording Budgets

Although budgetary accounts do not appear in thegeneral purpose financial statements, governmentstypically record budgets and governmental accounting

systems are designed to assure compliance withbudgets.

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Budgetary Accounts

Revenues to be raised pursuant to law during abudget period are set forth in an EstimatedRevenues budget.

An Appropriation, when enacted into law, is the legalauthorization for the government to incur liabilities forpurposes specified in the appropriations statue orordinance.

Estimated Other Financing Sources and EstimatedOther Financing Uses are budgetary accountsreflecting anticipated inflows and outflows of resourcesfrom sources other than revenues and expenditures

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Encumbrances

When a purchase order or contract is issued asauthorized by an appropriation, the governmentrecognizes this commitment as an

Encumbrance. An encumbrance is not a liability since the goods or

services have merely been ordered, not received.

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Encumbrances

Commitments are reflected in the budgetaryaccounts through the recording ofEncumbrances and the corresponding

Budgetary Fund Balance - Reserve forEncumbrances.

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Expenditure Cycle

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Encumbrance to Expenditure

Once goods or services are received, the governmenthas a liability. At this point, two journal entries arenecessary.

The first reverses the encumbrance at its original amount.Since the government has incurred an actual liability, it is nolonger necessary to reflect a commitment for the outstandingpurchase orders or contracts.

The second entry records the liability (Accounts Payable) and

an Expenditure in the amount of the invoice.

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Why Record Encumbrances? In business accounting, orders are not

entered into the general ledger Governments recognize that an outstanding order will

turn into an expenditure and a liability when the goodsarrive

To prevent over-spending, outstanding orders areentered into the books

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Encumbrance Example

Place an order for $150,000 which consists of three mini-busescosting $50,000 each. Recorded as:

Encumbrances 150,000Budgetary Fund Balance -Reserve for Encumbrances 150,000

Assume two of the buses arrive, but with freight, they cost $102,000instead of $100,000. First, reverse a part of the encumbrances:

Budgetary Fund Balance -Reserve for Encumbrances 100,000

Encumbrances 100,000 Second, record the actual amount of expenditure:

Capital Expenditure 102,000Accounts Payable 102,000

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Accounting for Revenues

Since taxes and many other revenues do notinvolve exchange transactions, governmentscannot determine the point at which these

revenues are earned. Therefore revenue recognition occurs when the

resulting resources are deemed to be bothmeasureable and available to finance expenditures

of the current period.

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Revenue Recognition

Nonexchange transactions are transactions in which agovernment receives resources without directly givingequal value in exchange.

The most common forms of nonexchange transactionsare tax revenues and intergovernmental grants.

Before a government may recognize revenue resultingfrom nonexchange transactions, it must meet a number of

eligibility requirements.

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Eligibility RequirementsNon-Exchange Revenues Required Characteristics of Recipients. The recipient must have

the characteristics specified by the provider.

Time Requirement. If time requirements (for expenditure) arespecified by the resource provider or legislation, those time

requirements must be met Reimbursement. For those grants and gifts that are payable only

upon the incurrence of qualifying outlays, revenues would berecognized only when the expenditures have been incurred.

Contingencies. Resources pledged that have a contingency

attached are not recognized as revenue until the contingency hasbeen met.

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Types of Nonexchange Transactions

1. Imposed nonexchange revenuesproperty tax, special assessments, fines/forfeits

1. Derived tax revenuessales, income, motor fuel taxes

1. Government mandated transactionsfederal government requires lower levelexpenditures

1. Voluntary nonexchange transactionsgrants, donations

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Imposed Nonexchange Revenue Taxes and other assessments that do not result

from an underlying transaction.

Examples include property taxes and special assessmentsimposed on property owners. Also includes fines and forfeits.

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Modified AccrualBasis Recognition

Record the receivable (and an allowance foruncollectibles) when an enforceable claim exits.

Revenues should be recognized in the period forwhich the taxes are levied (i.e. budgeted), but arealso subject to the 60 day rule. Revenues

expected to be collected > 60 days after year-endare deferred.

1. Property taxes levied

2. Deferral of portion

expected to be collected >60 days after year end

1. Taxes Receivable Dr

Estimated Uncollectible Taxes ...Cr

Revenues Control .Cr

2. Revenues Control DrDeferred Revenues Property Taxes Cr

Imposed Nonexchange Revenue

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Derived Tax Revenues

These are taxes assessed on exchangetransactions conducted by businesses or

citizens. Examples include sales, income, and excise taxes.

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Revenue Recognition Modified Accrual

Record the receivable when the taxpayers underlyingtransaction takes place.

Revenues should be recognized when available andmeasurable. Revenues not expected to be collected intime to settle current liabilities are deferred (i.e. available

and measurable criteria).1. Income tax withholdingsare received.

2. Additional income taxesexpected to be received

after year end. Part of thiswill not be received in timeto be avail-able for currentliabilities.

1. Cash .Dr

Revenues Control Cr

2. Taxes Receivable .Dr

Revenues Control Cr

Deferred Revenues Income Taxes Cr

Derived Tax Revenue

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Government MandatedNonexchange Transactions

These are commonly grants from higher levelsof government (federal or state) given to supporta program. Since the program is required, the lower-level

government has no choice but to accept. For example, a state may require schools to mainstream

certain students and provide funds to carry out thismandate.

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Voluntary NonexchangeTransactions

These include donations and grants given to

support a program.

Since the program is not required, the receivinggovernment voluntarily agrees to participate.

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Record the receivable and the revenue when alleligibility requirements have been met.

Many of these are reimbursement grants. In thiscase, revenue is recognized only when qualifiedexpenditures have been incurred.

Reimbursement typegrants

1. Expenditures Control ..Dr

Accounts Payable/Cash ..Cr

2. Due from grantor Dr

Revenues Control Cr

Government-Mandated and VoluntaryNonexchange Revenues

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Advance receipts are deferred until expendituresare incurred. Revenue recognition is subject tothe available and measurable criteria.

Advance fundedgrant:

1. Receipt of advancefunding.

2. Incur qualified

expenditures and recognizerevenue.

1. Cash DrDeferred Revenues Grants ..Cr

2a. Expenditures Control ...Dr

Accounts Payable/Cash ..Cr

2b. Deferred Revenues Grants .. Dr

Revenues Control Cr

Government-Mandated and VoluntaryNonexchange Revenues

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Recording the budget

Estimated Revenues 12,000,000

Estimated Other Financing Sources 500,000

Appropriations 11,700,000

Estimated Other Financing Uses 250,000

Budgetary Fund Balance 550,000

In the above entry, Budgetary Fund Balance is the expected change in fundbalance assuming actual amounts are exactly as budgeted. It may be

either a credit (or less frequently) or debit balance in the entry.

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Budget Revisions

Budget revisions may benecessary during the yeardue to changes in revenueprojections or operatingconditions for example,electricity price increases,decrease in sales taxesdue to low consumer

spending

Budget revisions usuallyare taken back to theappropriate legislativebody for approval,although somejurisdictions may allowsome percentage of thebudget to be transferred

between accounts

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Recording a budget revision

Budgetary Fund Balance 150,000

Appropriations 70,000

Estimated Revenues 80,000

In the above entry, the budget reflects a decrease in estimated revenues of$ 80,000 and an increase in appropriations of $ 70,000.

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Budgetary Comparison Schedule

Both the original and the final adjusted budgetis shown

The revised appropriations are compared to

the Actual Expenditures for the current periodplus Outstanding Encumbrances

A variance column is typically shown, but isoptional

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Budgetary Comparison Schedule

The actual columnshould use the basis of

accounting assumed inthe budget. This maybe different than GAAPbasis

Another schedule willreconcile the actual

figures on thebudgetary vs. GAAPbasis

Chap003 (2)

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