The Government and

Not-for-Profit Environment
Chapter One

Learning Objectives

Characteristics that distinguish governments and not-for profit

organizations from businesses.

The features that distinguish governments from not-for profits.

The overall purpose of financial reporting in government and

not-for profit sectors.

The information requirements of the main users of the

financial reports of governments and not-for-profit entities.

The specific objectives of financial reporting.

2

Before we start

The terms Not-for-profit and nonprofit

can be used interchangeably.

Through out the course, The letter G

refers to Government and the term NP
refers to NonProfit organization.

Introduction

Standard setting board for

state and local governments and governmental not-for

profits is Governmental Accounting Standards Board
GASB

federal government is Federal Accounting Standards

Advisory Board FASAB

private

sector,

including

nongovernmental

not-for-

profits is Financial Accounting Standards Board FASB

4

How do governments and

not-for profits compare with
businesses?

G and NP provide services targeted at groups of constituents

either advocating a political or social cause or carrying out
research or other activities for the betterment of the society.

The objectives of the G & NP are often ambiguous and not

easily quantifiable.

G&NP have relationships with parties providing their resources

that are unlike of businesses.

How do governments and

not-for profits compare with
businesses?
1.

Different Missions

The key objective of financial reporting is to provide information

about the entitys performance.

The main objective of a typical business is to earn profit

Financial statements can measure this through IS & CF.

Business may have objective that go beyond the bottom line.

promote the welfare of its executives & employees

improve the communities

Produce goods that will enhance the quality of life.

Cannot be measured by business accounting and reporting.
6

How do governments and

not-for profits compare with
businesses?
1.

Different Missions

Financial reports of G&NP provide information about Inflows

(Revenues) and outflows (Expenditures) of cash and other
resources.

Excess of expenditures over revenues generally signals

financial distress or poor managerial performance.

Excess of revenues over expenditures is not necessarily

commendable. It maybe achieved through reducing services,
which may be at odds with the entity's objective.
7

How do governments and

not-for profits compare with
businesses?
1.

Different Missions

The goal of G&NP is something other than earning profit.

To assess the organization's performance & to report properly on

their

accomplishments,

statements

to

include

G&NP

must

nonfinancial

augment
data

its

relating

financial
to

their

objectives, eg:

a school might include statistics on student test scores or graduation

rates.

A center for homeless might present data on the number of people fed
or adequately housed.
8

How do governments and

not-for profits compare with
businesses?
2. Budgets vs. the Marketplace
G&NP are governed mainly by their budgets, not the market

place.
Revenues

&

Expenditures

are

controlled

through

the

budgetary process.

G revenue maybe

determined by legislative fiat, G may not be

subject to the forces of competition faced by businesses.

NP revenues are obtained form contributions, dues, tuition or user

charges, non of which are comparable to the sales of businesses.
9

How do governments and

not-for profits compare with
businesses?
2. Budgets vs. the Marketplace

Although market mechanisms are widely thought of as

providing a more efficient distribution of goods and
services, they can operate only when there can be no
free riders*.

Many G services, such as police protection, can not be

provided only to paying customers. Hence we must
resort to nonmarket mechanism to allocate resources.
10

* Free riders are parties who are able to obtain the goods or services without paying for
them

How do governments and

not-for profits compare with
businesses?
3. Expenditures and Revenues

Expenditures drive revenues

G&NP establish the level of services that they will provide, calculate

their cost, and then set tax rates and other fees to generate the
revenues required to pay for the services.

Example: Uni, unlike businesses, do not set tuition fees at the

highest level that the market will bear, instead they calculate OPEX,
estimate contributions, endowment revenues, and other sources of
funds; and then set tuition charges at the rate necessary to cover
the shortfall.
11

How do governments and

not-for profits compare with
businesses?
3. Expenditures and Revenues

Expenditures drive revenues

Although G&NP do not participate in competitive

markets, they can not simply raise revenues without
regard to their services.

G may be constrained by political forces.

Universities may have to restrict their tuition rates to

approximately those of peer schools.
12

How do governments and

not-for profits compare with
businesses?
4. Preeminence of the Budget, not the
Annual Report
For businesses
the annual report is the most significant financial

document.
Annual budget is nothing more than an internal
document, rarely made available to investors.
For

G&NP

release of annual report is usually ignored by both

insiders & outsiders.

the budget takes the centre stage.

13

How do governments and

not-for profits compare with
businesses?
4. Preeminence of the Budget, not the
Annual Report
The

budget is the culmination of the political

process.
It

encapsulates almost all of the decisions made

by the organization.
which constituents give to the entity and which receive.
which activities are supported and which are charged.
14

How do governments and

not-for profits compare with
businesses?
4.

Preeminence

of

the

Budget,

not

the

Annual Report
The

budget is a source of constituent concern and

controversy.
G budget hearings often draw standing room only

crowds.
Church budget debates are frequently marked by more

intense fervor than worship services.

15

How do governments and

not-for profits compare with
businesses?
5. Budgets Drive Accounting & Financial Reporting
Constituents

of an organization want info

on the extent of adherence to the budget.

assurance that the org has not spent more than was authorized.
to know whether revenues and expenses estimates were

reliable.
The

accounting system and the financial reports must be

designed to provide that information.

16

How do governments and

not-for profits compare with
businesses?
5. Budgets Drive Accounting & Financial Reporting
Managers

need

an accounting system that provides them with ongoing data as to

whether they are on target to meet budget projections.

a system that prevents them from overspending or sets off warning

signals when they are about to do so.

Auditors

need a basis for assessing an organization's

performance.
The

budget is a control device, but it requires the support

of accounting and reporting system.

17

How do governments and

not-for profits compare with
businesses?
5. Budgets Drive Accounting & Financial Reporting
Budget

shows how much will be spent on a particular activity and

what the activity will achieve.

A

post period assessment focus on whether the entity met its revenue

and expenditure projections and if it achieved the expectations.

Evaluators

can then assess organizational efficiency and effectiveness

by comparing inputs (dollar exp) with outputs and outcomes (results).

The

accounting system should be designed to facilitate these

comparisons. Nonmonetary performance measures are important too.

18

How do governments and

not-for profits compare with
businesses?
6. Need to Insure Interperiod Equity

Most G are required by law, and NP are expected by policy to

balance their operating budgets.

Balanced operating budgets ensure that in any particular

period, revenues cover expenditures and that the entitys
constituents pay for what they receive.

If organizations fail to balance their budgets, and borrow to

cover operating deficits, then the cost of benefits enjoyed by
the citizens of today must be borne to those of tomorrow.
19

How do governments and

not-for profits compare with
businesses?
6. Need to Insure Interperiod Equity

Intergenerational

equity

Interperiod

equity

constituents pay for the services they receive and do not

shift the burdens to their children.
This does not mean that G should never borrow. The

prohibition against debt applies only to operating exp, not

capital exp.

Examples: a gov constructed highway will produce benefits over

YEARS financing through debt.

The accounting system of G & NP should provide whether

interperiod equity is being maintained.

20

How do governments and

not-for profits compare with
businesses?
7. Revenues not Indicative of Demand for Goods & Services
For

competitive business,

revenues signal customer demand for goods & services.

Holding Price constant, the greater the revenue, the greater the demand.
In

G & NP, revenues may not be linked to constituents demand or

satisfaction.
Increase in tax rates, tells nothing about the quality of service provided.
So, a conventional revenue and expenditure statement will tell nothing

about the demand, supplementary information is required.

21

How do governments and

not-for profits compare with
businesses?
8. No Direct Link Between Revenues & Expenditures
Revenues

are from donations may increase form year to

year, but the change may be unaccompanied by a

corresponding change in the quantity, quality or cost of
services provided.
Matching

principle,

For business attempt to match the costs of specific good with

revenues that they generated.

G & NP associate overall revenues with the broad categories of

expenditures they are intended to cover.

22

How do governments and

not-for profits compare with
businesses?
9. Different Role for Capital Assets
Unlike business, G & NP make significant investment in assets that

neither produce revenue nor reduce expenditures.

Thus conventional business practice for valuing capital assets,

PV(future cash flows), may not apply to G&NP.

A highway being considered by a G, will not yield cash benefits.

A college library may enrich the community intellectual life.

Some G&NP assets may be more properly interpreted as liabilities

because maintaining them will consume rather than provide
resources.

23

How do governments and

not-for profits compare with
businesses?
10. Restriction on Resources
Many of G &NP assets are restricted to particular activities.

Federal G may grant the state G a grant for construction of low income housing.

A city hotel tax may be dedicated to promote tourism.

A states gasoline tax may be targeted by law at highway construction.

G&NP need to must show in their financial reports that restricted

resources are unavailable for purposes other than those specified.

Accounting system must be designed so that management is

prevented from unintentionally misspending restricted resources.

G & NP employ a system of accounting known as Fund

Accounting.

24

How do governments and

not-for profits compare with
businesses?
11. No Distinct Ownership Interest

Neither G nor NP have defined ownership interests like those of

businesses.

G & NP cant be sold, or transferred, may be dissolved though.

A-L = some other term is requires instead of Owners Equity

Financial statements must be prepared for parties other than

stockholders.

G cant sell their highways.

The lack of ownership interest implies that unless the entire entity is
closed and its assets are liquidated, there may be little interest in the
market value of its resources.

25

How do governments and notfor profits compare with

businesses?
12. Less Distinction Between Internal & External Accounting
& Reporting

In the business sector:

In G & NP arena

1.External

1.

reports focus on
profits, and internal reports
present data on other measures
of performance .
2.The

budget
document.
3.There

is

an

internal

is
clear distinction
between internal and external
parties.

2.
3.

Profit is not an appropriate

measure of performance. The
relevant
performance
measures must be drawn from
the Org goals & are unlikely to
be the same for all users
groups.
The budget stands as the key
fiscal document.
The
distinction
between
internal and external parties is
more ambiguous than it is in
26
business.

What other characteristics of

Governments & not-for-profits have
accounting implications?
1.

Many different types of government & not-for

profits.

2.

Short

term

focus

of

managers

&

elected

officials
3.

Business type activities of government & notfor-profits.

27

What other characteristics of

Governments & not-for-profits have
accounting implications?
Many different types of government & not-

1.

for profits.
.

In USA: 87,900 local governments.

Created by and accountable to a higher level

government

State

Governments

are

accountable

to

Federal

Governments while

City

Governments

are

accountable

to

Governments, etc.
28

State

What other characteristics of

Governments & not-for-profits have
accounting implications?
Many different types of government & not-

1.

for profits.
.

In USA: 1.2 million not for profits

Each Firm (G or NP) will likely differ from others

in

Services it provides

Assets it controls

Taxing and borrowing authority (for G only)

Parties in which it is accountable

29

What other characteristics of

Governments & not-for-profits have
accounting implications?
1.

Many different types of government & notfor profits.

Their diversity limits the suitability of a common

accounting model. (set of accounting & reporting
principles).

Standard

setting

authorities

face

policy

question
To what extent should they adopt common
30
standards for all G &NP, as opposed to common

What other characteristics of

Governments & not-for-profits have
accounting implications?
1.

Many different types of government & notfor profits.

When entities are similar, common standards may

promote comparability.

When entities are not similar, common standards may

distort reality.

Rule making authorities are heading in the direction of

one set of common principles for all NPs and a
separate set for all state and local G.
31

What other characteristics of

Governments & not-for-profits have
accounting implications?
2. Short term focus of managers & elected
officials
Managers of both corporations and public enterprises have been

accused

of

sacrificing

the

long

term

welfare

of

their

organizations for short term benefits.

G officials face election every 2 or 4 years. In the periods

prior to election, they have incentives both to avoid
unpopular measures, such as tax increases, and to make
their G look fiscally sound.

They can use budgetary and accounting techniques to make

cosmetic improvements to their entity's budget or 32annual

What other characteristics of

Governments & not-for-profits have
accounting implications?
3. Business type activities of government and notfor-profits.

Cities operate electric utilities & trash collection

services

Universities operate bookstores & cafeterias

Even if profit maximization is not their objective, these

enterprises should be managed as if it were.

Therefore, managers and other parties need the same

financial information that owners and operators of
33

What other characteristics of

Governments & not-for-profits have
accounting implications?
3. Business type activities of government and notfor-profits.
The accounting and reporting practices that are appropriate

for the business type activities of G and NP may differ from

those that are more suitable for their nonbusiness activities.
Thus the challenge of developing accounting and reporting

principles for G & NP is made even more difficult by the

potential need for more than one set of standards, even
for a single organization.
34

How do Governments
compare with not-forprofits?
G

have

the

authority

to

command

resources

They have the power to tax, collect license fees,

and impose charges.

If a G lack funds to fulfill its obligations or enhance

services, it can obtain them by legislative action.

The

actual

assets

reported

on

government

balance sheet may not represent all of the assets

35

How do Governments
compare with not-forprofits?
There is no definitive criteria exist to distinguish between G
or NP. Characteristic of G:
1.

Power to tax

2.

G may issue tax-exempt debt

3.

The governing bodies are either popularly elected or

appointed by another government.

4.

Another G can unilaterally dissolve it and assume its

assets without compensation.
36

What are the overall purposes

of financial reporting?

Financial statements have values only to the extent

they serve the needs of users.

External financial statements should allow users to:

1. Assess financial condition
2. Compare actual results with the budget.
3. Determine

compliance

with

appropriate

laws,

regulations, and restrictions on the use of the funds.

4. Evaluate efficiency and effectiveness.

37

What are the overall purposes

of financial reporting?
1. Assess financial condition
.

Users need to analyze past results and current financial

conditions in order to determine the ability of the entity
to meet its obligations and to continue to provide
expected services.

Trend analysis (past vs. current performance) help

users to better predict the future fiscal developments
and to foresee the need to changes in revenue sources,
resource allocation and capital requirements.
38

What are the overall purposes

of financial reporting?
2. Compare actual results with the budget :
.

Given the importance of budget, users want assurance

that the entity adhered to budget.

3. Determine compliance with appropriate laws, regulations,

and restrictions on the use of the funds
.

Such as debt covenants, donor restrictions, debt

limitations.

39

What are the overall purposes

of financial reporting?
4. Evaluate efficiency and effectiveness

Users want to know whether the entity

achieved its objectives efficiently and effectively

by comparing Accomplishments (outcomes) with
service efforts and costs (resource inputs).

40

Users of Financial Reports

The basic financial statements & other information

in external reports are targeted mainly at parties

outside the organization to whom the organization is
accountable.
External

reports

may

not

be

appropriate

for

managerial decisions.

Executives & managers should rely on the internal

reporting system for financial information they require.
41

Users of Financial Reports

1.

Governing Boards

2.

Investors & Creditors

3.

Citizens & organizational members

4.

Donors & Grantors

5.

Regulatory Agencies

6.

Employees and other constituents

42

Users of Financial Reports

1. Governing Boards:

Governing board for a G is an elected or appointed

legislature.

Governing board for NP is the board of trustee or

board of directors.

43

Users of Financial Reports

1. Governing Boards:

Governing boards can't be categorized as either

Internal or External users.

The

GB

members

come

from

outside

the

management team

They

approve

budgets,

contracts,

executive

employment.

They

oversee

managers,

and

involve

managers decisions.
44

in

Users of Financial Reports

2. Investors & Creditors:
G and NP dont have owners, and do not issue

stocks.
G & NP use the same financial markets as business

to satisfy their debt financed capital requirements.

G issue Bonds to finance long term assets (roads,

highways, utility systems)

NP used bond financing for buildings & equipment.

45

Outstanding Level of public and private debt, 2004

5000
4000
3000

$ billions
2000
1000
0

Municipal

Us Corporate

State & local G had an estimate of $2 trillion of bonds

outstanding. This compares with $4,6 trillion outstanding for
US corporations.

The amounts highlights the economic significance of the

municipal bond segment.

The main purchasers of this debt are households and mutual

funds.
46

Users of Financial Reports

2. Investors & Creditors:

Investors usually include G & NP bonds as well

as corporate bonds in their investment portfolio.

Investors want assurance that the issuer (G, NO,

or

corporate)

will

meet

interest&

principal

payments.

47

Users of Financial Reports

2. Investors & Creditors:
Most bondholders are indirect users of financial

reports. They reply on the assessment of bond

rating services like Standard & Poors.

These services assign to publicly traded bonds a

rating (AAA, AA, A, BBB) reflective

of the

securities risk of default.

48

Users of Financial Reports

2. Investors & Creditors:

G & NP borrow from banks to finance CAPEX or

short term imbalance in their operations.

Lenders use financial statements of G & NP to

assess their credit worthiness.

49

Users of Financial Reports

3. Citizens & Organizational members:

Citizens (or taxpayers) are significant users of

financial reports.

In reality few citizens ever see FR, perhaps the

reports are slow to appear and are not user
friendly.

50

Users of Financial Reports

3. Citizens & Organizational members:

Citizens obtain the data through variety of

filters:

Civic associations, political groups, & media.

Citizens may not take attention, but

they

definitely notice the financial mismanagement

that may cause unexpected revenue shortfall or
cost overruns.
51

Users of Financial Reports

3. Citizens & Organizational members:
The members of a NP interest in the financial statement

depend on

Organization's Size and membership involvement.

Country club members may pay more attention to the

financial affairs of the club, than do the members of
broader based organizations like National Geography
Society. Because the country clubs financial position
and performance more directly affect their dues and
fees.
52

Users of Financial Reports

4. Donors & Grantors:

Major donors and grantors analyze the financial

reports carefully.

Individual

donors

should

also

obtain

financial

information before contributing.

Information should be available from the org or from

regulatory authorities.
53

Users of Financial Reports

5. Regulatory Agencies:

Local governments usually are required to file

financial reports with state agencies.

Charitable organizations are required to file

financial reports with state or local authorities

54

Users of Financial Reports

5. Regulatory Agencies:

Regulatory authority
ensure that entities are spending and receiving

resources in accordance with law, regulations, or

policies.
Assess management performance
To allocate resources
Exercise general oversight.
55

Users of Financial Reports

6. Employees and other constituents:

Labor

union

may

examine

the

financial

statements looking for way to salary increase.

Students have been known to use budgets and

annual reports to support their claims that the
university need not raise tuition, or can afford a
new student centre.
56

Objectives of Financial
Reporting

The overall objective of financial

reporting is to meet the information
needs of report users.

GASB objectives.

FASB objectives

57

Objectives of Financial
Reporting
FASB Objectives:

Financial reporting by nonbusiness organization

should provide information that is useful to
present and potential resource providers and
other users in making decisions about the
allocation of resources to those organizations.

58

Objectives of Financial
Reporting
FASB Objectives:

Financial reporting should provide information

to help present and potential resource providers
and other users in assessing the services that a
nonbusiness

organization

provides

and

ability to continue to provide those services.

59

its

Objectives of Financial
Reporting
FASB Objectives:

Financial reporting should provide information

that is useful to present and potential resource
providers and other users in assessing how
managers of a nonbusiness organization have
discharged their stewardship responsibilities
and about other aspects of their performance.

60

Objectives of Financial
Reporting
FASB Objectives:

Financial reporting should provide information

about the economic resources, obligations, and
net resources of an organization, and the
effects

of

circumstances

transitions,
that

change

events,

and

resources

and

interests in those resources.

61

Objectives of Financial
Reporting
FASB Objectives:

Financial reporting should provide information

about the performance of an organization
during a period, periodic measurement of the
changes in the amount and nature of the net
resources of a nonbusiness organization, and
information

about

the

service

efforts

accomplishments of an organization.
62

and

Objectives of Financial
Reporting
FASB Objectives:

Financial reporting should provide information

about how an organization obtains and spends
cash

or

other

liquid

resources,

about

its

borrowing, and repayment of borrowing, and

about

other

factors

that

may

affect

organization's liquidity.

63

the

Objectives of Financial
Reporting
FASB Objectives:

Financial reporting should Include explanations

and interpretations to help users understand
financial information provided.

64

Objectives of Financial
Reporting
Service Efforts & Accomplishments seen as a Longterm Goal:

FASB noted that financial reporting should encompass

information on service efforts and accomplishments.

This information can not be easily expressed in monetary

units and has not traditionally been included in financial
statements.

FASB emphasize that the ability to measure accomplishments

is still undeveloped.

FASB sees the aspect of performance reporting as a long

65 term

Do Differences in Accounting
Principles really matter?

Financial statements demonstrate what happened to an entity

in the past.

FS present the evidence from the perspective of the

accountant who prepares them. Other accountants may
describe the events differently.

The accounting principles dictate how the evidence is

presented.
Does the difference in Accounting Principles change the
decision made on the basis of financial statements?

66

Do Differences in Accounting
Principles really matter?
User Adjustment:

Users of financial statements can be indifferent to how an

entity's fiscal story is told, as long as they are given
adequate information.

Research in corporate sector provides evidence that

stockholders are able to see through the differences and
adjust financial statements to take the difference into
account.

67

Do Differences in Accounting
Principles really matter?
User Adjustment:

The efficiency of the municipal bond market has been

investigated much less than the efficiency of the stock
market. .

Efficiency refers to the extent to which the price of the bond incorporates all
public information.
68

Do Differences in Accounting
Principles really matter?
Economic Consequences :

The

accounting

principles

frequently

have

economic consequences.

Important decisions are made based on the

financial data.

69

Do Differences in Accounting
Principles really matter?
Economic Consequences :
The choice of accounting principles is critical:

Most G budget on cash or near cash basis. If they were

required to budget on full accrual basis, their budgets
might unbalance.

70

Do Differences in Accounting
Principles really matter?
Economic Consequences :
The choice of accounting principles is critical:

G may face restrictions on the amount of debt they incur. The

use of one set of accounting principles in defining &
measuring debt (not counting lease as an obligation) might
enable them to issue additional bonds. The use of different
set (counting lease as obligation) might cause them to
exceed the limits and be barred from borrowing.

71

Who establishes GAAP?

Generally

Accepted

Accounting

Principles

(GAAP)

embrace the rules and conventions that guide the form

and content of general purpose financial statements.

Primary standard setting authorities(GASB, FASAB, &

FASB) has been sanctioned by AICPA.

72

Entities common to G & NP

sectors

FASB, created in 1973, has directed its intention to

business enterprises rather than not-for-profits. In 1979,
it assumed responsibility of NP.

GASB have authority over all state and local government

entities including government colleges and government
universities and government hospitals.

FASB have authority on all other entities including

private colleges and universities.
73

End of Topic One

74