Chapter

Accounting for Governmental Operating ActivitiesIllustrative Transactions and Financial Statements

McGraw-Hill

2003 The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives
After studying Chapter 4, you should be able to:

Recognize typical operating transactions for the governmental activities and prepare appropriate journal entries at both the government-wide and ` fund levels. Account for expense recognition at the government-wide level and expenditures at the fund level for goods encumbered in the prior year. Explain the contents of interim balance sheets and budgetary comparison schedules.

Learning Objectives (Contd)

Explain

the difference between exchange and nonexchange transactions, and the classifications of nonexchange transactions. Explain and make entries for internal exchange transactions. Prepare adjusting entries, including reclassification of property taxes to delinquent status, accrual of interest and penalties for property taxes, and adjustment for inventories.

Learning Objectives (Contd)

Prepare a pre-closing trial balance for the General Fund. Prepare closing journal entries. Prepare year-end General Fund financial statements. Account for operating grants and other financial assistance using special revenue funds.

Learning Objectives (Contd)

Account

for interfund transactions; distinguish between intra- and inter-activity transactions; and explain accounting for intra-entity transactions for transactions of a permanent fund.

Account

Key Terms
Consumption method Delinquent taxes Derived tax revenues Eligibility requirements Exchange-like transaction Government-mandated nonexchange transaction Gross tax levy Imposed nonexchange revenue Inter-activity transactions Interfund loans Interfund transfers Internal exchange transactions Intra-activity transactions Intra-entity transactions Nonexchange revenue Nonexchange transactions Permanent fund Private-purpose trusts Public-purpose trusts Purchases method Purpose restrictions Tax anticipation note Tax rate Time requirements Voluntary nonexchange transactions

Governmental Funds

Focus: measure the flow of current financial resources

Current financial resources include cash, receivables, marketable securities, prepaid items, and supplies inventories Capital assets such as land, buildings, and equipment are not accounted for in governmental funds, but rather in governmental activities at the governmentwide level

Basis: modified accrual accounting

Recording the Budget at the Beginning of the Year

The budget for the Town of Brighton authorizes expenditures of $4,180,000, but forecasts revenues of only $3,986,000 for FY 2005.
Q: Is this an example of poor financial management? (See next slide)

Q: Is This an Example of Poor Financial Management?

A: A budgetary deficit does not necessarily indicate
poor financial management.
To

provide a reserve for revenue shortfalls or unexpected expenditure needs, many governments maintain a target ratio of Unreserved Fund Balance (the amount available at the beginning of the year) to General Fund Revenues in the range of 10 to 20 percent. If the fund balance is larger than desired, the City Council (or other legislative body) may intentionally budget a deficit to reduce fund balance.

Encumbrance Accounting

Before a department can order materials and supplies or equipment, the finance department ordinarily must verify that a sufficient unexpended appropriation exists to cover the items being ordered.

This process is sometimes referred to as preauditing

Encumbrance Accounting (Contd)

Assume that the following departments of Macon City order materials and supplies amounting in total to $420,000, the entry would be:
GF General Journal Encumbrances2005 Reserve for Encumbrances2005 Encumbrances Subsidiary Ledger: General Government Public Safety Public Works Dr. 420,000 Cr. 420,000 80,000 210,000 130,000

Accounting for Expenditures

Macon City recorded the following expenditures of $432,000 for goods received that had been ordered in the preceding transaction. GF General Journal
Reserve for Encumbrances2005 Expenditures2005 Encumbrances2005 Vouchers Payable Dr. 420,000 432,000 Cr.

420,000 432,000

Accounting for Expenditures (Contd)

Expenditures Subsidiary Ledger: General Government Public Safety Public Works Dr. 78,000 220,000 134,000 Cr.

Encumbrances Subsidiary Ledger: General Government Public Safety Public Works

80,000 210,000 130,000

Accounting for Payroll

Payroll accounting is similar for a governmental fund and a for-profit entity, except Expenditures rather than Expenses are recorded
Debit

Expenditures for full amount of payroll and credit liabilities for withholdings from employees pay; credit Cash for the amount paid to employees Record Expenditures for the employers payroll costs, including employers share of FICA and credit a liability to federal government

Encumbrances usually are not recorded for recurring expenditures such as payroll

Accounting for Payroll (Contd)

Macon City recognized its payroll for the most recent two week pay period for employees paid from the General Fund.
GF General Journal Expenditures2005 Due to Federal Govt Due to State Govt Cash Dr. 948,000 Cr. 86,000 49,000 713,000 178,000 480,000 290,000

Expenditures Subsidiary Ledger: General Government Public Safety Public Works

Accounting for Payroll (Contd)

The employers share of FICA is recorded.

GF General Journal
Expenditures2005 Due to Federal Govt

Dr.
88,000

Cr.
88,000

Expenditures Subsidiary Ledger: Contributions for Retirement 88,000

Accounting for Property Tax Revenue

The tax levy is the amount billed to taxpayers. Calculation of levy: Levy = (Statutory or legislatively approved tax rate * assessed valuation of taxable property (either real property or personal property)) An additional calculation of levy: Levy = Revenues required Estimated collectible proportion

Accounting for Property Tax Revenue (Contd)

The tax rate is the measure that is actually set by legislative action, after the required size of the levy is determined. Required tax rate (per $100 or per $1,000 of assessed valuation) = tax levy assessed valuation

Accounting for Property Tax Revenue (Contd)

Assessed valuation is determined by an elected Tax Assessor Calculation: Assessed valuation = Estimated True Value * Assessment Ratio In some jurisdictions the assessment ratio is 1.00 (i.e., full estimated market value), other jurisdictions it might be .30 or some other fraction of full value.

Accounting for Property Tax Revenue (Contd)

Assume Revenues of $495,000 are required and it is estimated that 1% will be uncollectible: Levy = $495,000/.99 = $500,000. (ignore subsidiary ledger entry)
GF General Journal Taxes Receivable-Current Est. Uncollectible Current Taxes Revenues Dr. 500,000 Cr. 5,000 495,000

Accounting for Property Tax Revenue (Contd)

Assume by end of year $450,000 of current taxes have been collected, the entry is: GF General Journal
Cash Taxes ReceivableCurrent

Dr.
450,000

Cr.
450,000

Accounting for Property Tax Revenue (Contd)

The entry to reclassify uncollected current taxes to delinquent status at year-end:
GF General Journal Taxes ReceivableDelinquent Estimated Uncollectible Current Taxes Taxes ReceivableCurrent Estimated Uncollectible Delinquent Taxes Dr. 50,000 5,000 Cr.

50,000
5,000

Accounting for Property Tax Revenue (Contd)

Interest and penalties of $500 were accrued on delinquent taxes, of which 10% was estimated to be uncollectible.
GF General Journal Interest and Penalties Receivable on Taxes Estimated Uncollectible Interest and Penalties Revenues Dr. 500 Cr. 50 450

(An entry would also be required in the Revenues subsidiary ledger)

Accounting for Property Tax Revenue (Contd)

Write-off of uncollectible taxes. Assume property taxes of $500 were written off, on which there was accumulated interest and penalties of $80. The required journal entry is:
GF General Journal Estimated Uncollectible Delinquent Taxes Estimated Uncollectible Interest & Penalties Taxes ReceivableDelinquent Interest and Penalties Receivable on Taxes Dr. 500 80 Cr.

500 80

Issuance of Tax Anticipation Notes (TANs)

Revenues from property taxes are often collected during one or two months of the years Expenditure demands may occur more or less uniformly during the year A local bank may extend a line of credit in the form of TANs to meet short-term cash needs since they will have the power of lien over taxable properties

Tax Anticipation Notes - TANs (Contd)

Assume on April 1, 2005, a hypothetical city, Macon City, signs a 60-day $300,000 tax anticipation note, discounted at 6 percent per annum. GF General Journal
Cash Expenditures2005 Tax Anticipation Notes Payable Note: .06 X 60/360 X $300,000 = $3,000 Dr. 297,000 3,000 Cr.

300,000

Tax Anticipation Notes - TANs (Contd)

Macon City repaid the 60-day $300,000 tax anticipation note on the due date. GF General Journal
Tax Anticipation Notes Payable Cash
Dr. Cr. 300,000 300,000

Interim Balance Sheet (see Ill. 4-2)

Balance sheet equation at an interim point during the year (e.g., end of first quarter):
Assets + Budgetary Resources = Liabilities + Available Appropriations + Reserved Fund Balance + Unreserved Fund Balance

Interim Balance Sheet (Contd)

Budgetary resources is the amount of unrealized estimated revenues to date (estimated revenues minus actual revenues)

Available Appropriations is the amount of appropriations that has not yet been expended or encumbered. It is one component of Fund Equity at an interim point during the year.

Revision of the Budget During the Year

Q: Why might a government need to revise its

legally adopted budget during the year?

Q: How are budget revisions accounted for?

Discuss.

Q: Why Might a Government Need to Revise its Legally Adopted Budget During the Year?
A: An error may have been made in estimating revenues or expenditures, or changed conditions may have altered estimated revenues or caused unforeseen expenditure needs.
Because the budget is legally binding on managers, it is important that the budget be revised to reflect changed conditions.

Q: How are Budget Revisions Accounted for?

A: If estimated revenues is increased, debit Estimated Revenues and credit Fund Balance. If appropriations are increased, debit Fund Balance and credit Appropriations. A decrease in either item would result in the reverse of the above entry. Subsidiary ledger detail accounts would be adjusted accordingly.

Encumbrances of a Prior Year

Accounting for encumbrances depends on the budget laws of a particular state or other government

In a minority of jurisdictions, appropriations do not expire at year-end. In a few jurisdictions, appropriations lapse and encumbrances for goods on order at year-end require a new appropriation in the next fiscal year We examine the most usual situation: Appropriations lapse, but the government will honor encumbrances for goods still on order at year-end

Encumbrances of a Prior Year (Contd)

Assume at the end of FY 2004, a Reserve for Encumbrances was reported for $8,300. Early in FY 2005, the goods were received at an actual cost of $8,500. First it is necessary to re-establish the Encumbrances 2004 account balance, as follows
GF General Journal Dr. Cr.

Encumbrances2004 Fund Balance

8,300 8,300

Encumbrances of a Prior Year (Contd)

After the $8,300 encumbrance has been re-established, the following entry records the receipt of the goods early in FY 2005 at an actual cost of $8,500. GF General Journal Dr. Cr.

Reserve for Encumbrances2004 Expenditures2004 Expenditures2005 Encumbrances2004 Vouchers Payable

8,300 8,300 200 8,300 8,500

Note that only $200 is charged to the FY 2005 appropriation

Encumbrances of a Prior Year (Contd)

In the preceding example, what if the actual cost of the goods received had been only $8,100? How would this affect the journal entries?

Encumbrances of a Prior Year (Contd)

Assume now the actual cost of the goods received in early FY 2005 had been only $8,100 rather than $8,500.
GF General Journal Reserve for Encumbrances2004 Expenditures2004 Encumbrances2004 Vouchers Payable Dr. 8,300 8,100 Cr.

8,300 8,100

Note that the FY 2005 appropriation is unaffected.

Accounting for Inventories

Two methods of accounting

Consumption

Method Purchases Method

Under each method we assume that periodic rather than perpetual inventory accounts are maintained; All purchases are debited to Expenditures and that the Inventory of Supplies account is updated at yearend as an adjusting entry

Accounting for Inventories (Contd)

Consumption Method. Assume the following data:
Beginning inventory Purchases during year Available for use Ending inventory Amount consumed $ 20,000 $150,000 $170,000 $ 15,000 $155,000

Adjusting Journal Entries:

Expenditures2004 Inventory of Supplies Reserve for Inventory of Supplies Fund Balance

DR
5,000

CR
5,000

5,000 5,000

Accounting for Inventories (Contd)

Purchases Method. Assuming the same data:
Beginning inventory Purchases during year Available for use Ending inventory Amount consumed $ 20,000 $150,000 $170,000 $ 15,000 $155,000

Adjusting Journal Entries:

Reserve for Inventory of Supplies Inventory of Supplies

Dr.
5,000

Cr.
5,000

Note that the Expenditures account is not affected by the adjusting entry.

Closing Journal Entries

Alternative methods, any of which is acceptable

Close Estimated Revenues and Revenues in one entry and Appropriations, Encumbrances, and Expenditures in a second entry, debiting or crediting Fund Balance as necessary in each entry Close budgetary accounts (Estimated Revenues, Appropriations, and Expenditures) in one entry and Proprietary accounts (Revenues and Expenditures) in a second entry, debiting or crediting Fund Balance as necessary, in each entry. Close all temporary accounts in one entry, debiting or crediting Fund Balance as necessary

Special Revenue Fund Accounting

Purpose Created when revenues are received that
are earmarked for a specific operating purpose.

Examples

motor fuel taxes earmarked for streets, roads, and bridges and
federal grant to operate a counseling program for troubled youths.

Accounting, budgeting, and financial reporting are essentially the same as for the General Fund.

Accounting for Operating Grants

Assume a grant of $100,000 is received at the beginning of the fiscal year from the federal government to operate a counseling program for troubled youths. Until the grant has been earned by meeting eligibility requirements related to service recipients, it is reported as Deferred Revenuea liability. The entry in the special revenue fund is:
Cash Deferred Revenue

Dr. 100,000

Cr.
100,000

Accounting for Operating Grants (contd)

Assume that during the year the Counseling Program expended $75,000 for costs related to youth counseling, while meeting eligibility requirements, the entries would be:
Dr. 75,000 75,000 75,000 Cr. 75,000

Expenditures Vouchers Payable Deferred Revenues Revenues

(This amount would also be recorded in the Revenue detail account in the Revenue subsidiary ledger.)

SRF - Required Financial Statements

Report special revenue fund activity in the governmental activities section of the governmentwide financial statements. Provide a column in the governmental funds balance sheet and statement of revenues, expenditures, and changes in fund balances, if SRF meets the definition of a major fund (see Ill. 1-7)

Other Topics

Not essential for a basic understanding, but that students are encouraged to read.
Correction

of errors

Cash

basis recognition of tax revenue for discounts on taxes

Accounting

Internal Exchange Transactions

o

Transactions between two funds that are similar to those involving the government and an external entity.

Example: Billing from a Citys water utility fund (an enterprise fund) to the Citys General Fund for the Fire Department.

The funds recognize a revenue and expenditure, respectively, rather than operating transfers in and out These transactions are eliminated prior to preparing the government-wide financial statements.

Interfund Activity
Interfund loans

Loans made from one fund to another with the intent that they are to be repaid. Classified as Interfund Loans Receivable- Current (or Payable-Current), if the intent is to repay during the current year; otherwise Noncurrent. Nonreciprocal activity in which other financing sources and uses are transferred between funds with no intention of repayment. The superseded model further separated these into operating transfers and residual equity transfers.

Interfund transfers

Intra- versus Inter-Activity Transactions

Intra-activity transaction A transaction between two governmental funds (including an internal service fund) or between two enterprise funds. Neither governmental activities nor business-type activities are affected at the government-wide level. Inter-activity transaction Interfund loans or transfers between a governmental fund (including internal service fund) and an enterprise fund. Report these as Internal Balances on the governmentwide Statement of Net Assets and Transfers in the Statement of Activities.

Intra-Entity Transactions
Exchange or nonexchange transactions between the primary government and its blended or discretely presented component units. A/R and A/P from these transactions are reported on a separate line in the Statement of Net Assets.

Permanent Funds
To

account for contributions received under trust agreements in which the principal amount is not expendable, but earnings are. intended to meet a public-purpose (i.e., to benefit a government program or function, or the citizenry, rather than an external individual, organization, or government. new classification under GASBS 34; formerly classified as nonexpendable Fiduciary Funds.

Specifically

Exchange Transactions

Transactions in which each party receives value essentially equal to the value given

e.g., one party sells goods or services and the other buys

Recognize the revenue when it is earned, and the expense/expenditure when it is incurred. Exchange-like transactions are those in which the values exchanged may be related but not quite equal.

Nonexchange Transactions

External events in which a government gives/receives value without directly receiving/giving equal value in exchange Revenue recognition depends on time requirements the period in which the resources are required (or may be) used In some cases, revenue recognition may be delayed until program eligibility requirements are met. Purpose restrictions reported as restricted net assets or reserved fund balance

Classes of Nonexchange Transactions

Derived tax revenues

e.g., income and sales taxes e.g., property taxes and fines and penalties

Imposed nonexchange revenues

Government-mandated nonexchange transactions

e.g., certain services funded by a higher level of government e.g., grants and entitlements from higher levels of government and certain private donations

Voluntary nonexchange transactions

Revenue Recognition Criteria for Nonexchange Transactions

Derived tax revenues

in the period in which the underlying exchange occurs

Imposed nonexchange revenues

when there is an enforceable legal claim or the period for which levied in the case of property taxes
when all eligibility requirements have been met. If cash is received before eligibility requirements have been met, Deferred Revenues would be credited Same as above

Government-mandated nonexchange transactions

Voluntary nonexchange transactions

Concluding Comments

Mastery of the revenue and expenditure accounting principles covered in Chapter 4 is essential to a sound understanding of governmental fund accounting, as well as understanding accounting and financial reporting for the other governmental funds discussed in the following chapters. The General Fund and special revenue funds encompass most of the operating activities of the typical government

End