Accounting for governmental and nonprofit entities 15th edition by wilson reck and kattelus

Brief Contentsx Preface v 1 Introduction to Accounting and Financial Reporting for Governmental and Profit Entities 1 Not-for-PART ONE 2 Principles of Accounting and Financial Reporting

Accounting for Governmental and Nonprofit Entities

Fifteenth Edition

Earl R Wilson, Ph.D., CPA

Professor Emeritus University of Missouri—Columbia

Jacqueline L Reck, Ph.D., CPA

Associate Professor and James E

and C Ellis Rooks Distinguished Professor in Accounting University of South Florida

Susan C Kattelus, Ph.D., CPA, CGFM

Professor of Practice Michigan State University

Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St Louis Bangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

ACCOUNTING FOR GOVERNMENTAL AND NONPROFIT ENTITIES

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American Institute of Certified Public Accountants, Inc materials reproduced are copyright © 2008 by AICPA, reproduced with permission Portions of various GASB documents, copyright by the Governmental Accounting Standards Board, 401 Merritt 7, PO Box 5116, Norwalk,

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Library of Congress Cataloging-in-Publication Data

Wilson, Earl Ray,

1939-Accounting for governmental and nonprofit entities / Earl R Wilson, Jacqueline L Reck,

Susan C Kattelus.—Fifteenth ed.

p cm.

Includes index.

ISBN-13: 978-0-07-337960-9 (alk paper)

ISBN-10: 0-07-337960-3 (alk paper)

1 Finance, Public—Accounting 2 Nonprofit organizations—Accounting 3 Nonprofit

organizations—United States—Accounting I Reck, Jacqueline L II Kattelus, Susan C (Susan

Convery) III Title

About the Authors

In Memoriam: This edition is dedicated to the memory and long service

of Dr Leon E Hay as an author of the third through twelfth editions of

Accounting for Governmental and Nonprofit Entities Dr Hay was a

nationally recognized leader and educator in the field of governmental and not-for-profit accounting.

Earl R Wilson

Is Professor Emeritus of Accountancy at the University of Missouri—Columbia Hereceived his BA and MBA from Chapman University and his MA and PhD in Accoun-tancy from the University of Missouri—Columbia He is a certified public accountant(Missouri)

Professor Wilson has contributed substantially to standards setting in governmentalaccounting and auditing, having served as an academic fellow with the GovernmentalAccounting Standards Board (GASB) and as a member of the Governmental AccountingStandards Advisory Council, the U.S Comptroller General’s Advisory Council onGovernmental Auditing Standards, the American Institute of CPAs GovernmentAccounting and Auditing Committee, and as chair of the Missouri Society of CPAs(MSCPA) Government Accounting Committee and president of the American AccountingAssociation Government and Nonprofit (AAA-GNP) Section In addition, he has served

on several GASB task forces and conducted financial reporting research for the GASB

Dr Wilson has published numerous research articles in journals such as The

Accounting Review; Journal of Accounting Research; Contemporary Accounting Research; Journal of Accounting and Public Policy; Journal of Accounting, Auditing, and Finance; Research in Governmental and Nonprofit Accounting; Public Budgeting and Finance, and others Many of these articles are frequently cited as influential

studies of the municipal bond market He has been an author of this text since the ninthedition in 1992 He has extensive experience teaching governmental and nonprofitaccounting, including online courses

Professor Wilson has received a number of awards for his teaching and research,including the Enduring Lifetime Contribution Award from the AAA-GNP section, the

2003 Cornelius Tierney/Ernst & Young Research Award from the Association ofGovernment Accountants, Outstanding Teacher of the Year for 2002 from the KansasCity MU Business Alumni Association, and the 2000 Outstanding Educator of the Yearand 2008 Outstanding CPA in Government awards from the MSCPA He has chaired

or served as reader of more than 30 doctoral dissertations, many in the area ofgovernmental accounting

Jacqueline L Reck

Is an associate professor and the James E and C Ellis Rooks Distinguished Professor

in Accounting for the School of Accountancy at the University of South Florida Shereceived a BS degree from North Dakota State University, BS and MAcc degrees fromthe University of South Florida, and her PhD from the University of Missouri–Columbia.She is a certified public accountant (Florida)

iii

Dr Reck worked for state government for several years before joining academia.Currently, she is active in several professional associations In addition to teachinggovernmental and not-for-profit accounting, Dr Reck frequently presents continuingprofessional education workshops and sessions She has provided workshops ongovernmental and not-for-profit accounting for local accounting firms and the stateauditor general’s staff Dr Reck has received several teaching and research awards, iscurrently the doctoral program coordinator for the School of Accountancy, and haschaired or served on several doctoral dissertation committees.

Dr Reck has published articles in The Journal of Accounting and Public Policy;

Research in Governmental and Nonprofit Accounting; Journal of Public Budgeting, Accounting and Financial Management; and the Journal of Information Systems,

among others She joined as an author on the 14th edition

Susan C Kattelus

Is Professor Emeritus of Accounting at Eastern Michigan University and currently aProfessor of Practice at Michigan State University She received her BBA and PhDfrom Michigan State University and MSA from Eastern Michigan University ProfessorKattelus is a certified public accountant (Michigan) and a certified governmentfinancial manager

Professor Kattelus has served on the Governmental Accounting Standards AdvisoryCouncil as the academic representative of the American Accounting Association(AAA), president of the Government and Nonprofit Section of the AAA, and chair ofthe Nonprofit Task Force of the Michigan Association of CPAs She teaches the publicand nonprofit accounting course for accounting majors and the principles of managerialaccounting course for business students

Dr Kattelus has published articles in The Accounting Review; Research in

Governmental and Nonprofit Accounting; Journal of Government Financial Management; Public Budgeting and Finance; Issues in Accounting Education; Journal of Accounting Education; and Journal of Public Budgeting, Accounting and Financial Management,

among others She joined as an author on the 11th edition in 1999

iv About the Authors

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For almost 60 years, Accounting for Governmental and Nonprofit Entities has been the

leader in the market It is a comprehensive governmental and not-for-profit accountingtext written for students who will be auditing and working in public and not-for-profitsector entities Originally published in 1951 and written by Professor R M Mikesell,this book—and the several subsequent editions revised by Professor Leon E Hay—hasgiven generations of instructors and students a comprehensive knowledge of the spe-cialized accounting and financial reporting practices of governmental and not-for-profit organizations, as well as an understanding of how those organizations can bettermeet the information needs of a diverse set of financial statement users and decisionmakers The vision of these original authors continues to be reflected in this 15th edition,and their strategy of providing a large and innovative set of instructional supportmaterials prepared and tested in the classroom by the authors continues to be a guidingprinciple today The current author team brings to this edition their extensive experi-ence teaching government and not-for-profit courses as well as insights gained fromscholarly writing and professional activities The result is a relevant and accurate textthat includes the most effective instructional tools

ORGANIZATION AND CONTENT

The 15th edition of Accounting for Governmental and Nonprofit Entities is separated

into three parts: Part I covers state and local governments (Chapters 2 through 10), Part

II focuses on accountability for public funds (Chapters 11 through 13), and Part IIIexamines not-for-profit organizations (Chapters 14 through 17) Chapter 1 continues

to form a broad foundation for the more detailed material in Chapters 2–17 The order

of the chapters is similar to previous editions, but some topics and chapters have beenrearranged to facilitate a variety of courses and formats used by adopters of the text.For example, a course focused on state and local governments may cover Chapter 1 andParts I and II, while a course focused on not-for-profit organizations may coverChapter 1 and Parts II and III Part II is a bridge between the public and not-for-profitsectors that includes accountability topics (e.g., federal government, auditing, andbudgeting) applicable to all types of entities that receive public funds

KEY CHANGES IN THIS EDITION

As always, readers can count on this edition to include authoritative changes from theFinancial Accounting Standards Board, Governmental Accounting Standards Board,Federal Accounting Standards Advisory Board, American Institute of Certified PublicAccountants, Office of Management and Budget, Internal Revenue Service, andGovernment Accountability Office Update bulletins will be provided periodically onthe text Web site as new authoritative statements are issued

Several significant changes have been made in this edition of the text The samplefinancial statements have been moved to an appendix in Chapter 1 and the manage-ment’s discussion and analysis (MD&A) has been moved to an appendix in Chapter 9for easier reference A new appendix on managing investments has been added toChapter 8 In a slight reorganization of coverage, what was formerly Chapter 11,

“Auditing of Governmental and Not-for-Profit Organizations,” is now Chapter 12 This

v

chapter also has been modified to increase its focus on generally accepted governmentauditing standards In Chapter 13, more emphasis has been placed on performancegiven the unique nature of governments In addition, an appendix on cost and budgetissues in grant accounting has been added to Chapter 13 Illustrative financialstatements for the American Heart Association and related discussion have beenincorporated into Chapter 14.

In addition to these changes, all chapters have been updated to reflect changes in theareas of accounting and auditing affecting governments and not-for-profit entities.Based on comments received and the collective experience of the authors, some items

in this edition have received increased attention (e.g., major funds and postemploymentbenefits) A most significant enhancement is that this edition now features a secondcomputerized practice set, the City of Bingham, which is equally as comprehensiveand effective as the widely used City of Smithville practice set Both practice sets arenow downloadable from the publisher’s Web site (for more information, see inside thefront cover of this text)

INNOVATIVE PEDAGOGY

For state and local government accounting, the authors have found that dual-track

accounting is an effective approach in showing the juxtaposition of government-wideand fund financial statements in GASB’s integrated model of basic financial state-ments It allows students to see that each transaction has an effect on the fund financialstatements (that are designed to show fiscal compliance with the annual budget), on thegovernment-wide financial statements (that demonstrate accountability for operationalperformance of the government as a whole), or both This approach better servesstudents who will design and use accounting information systems, such as enterprisesystems, to allow information to be captured once and used for several purposes.Accounting for federal agencies as well as nongovernmental, not-for-profit entitiesclosely parallels this approach as traditional fund accounting may be appropriate forkeeping track of resources with restricted purposes, but citizens and donors also need

to see the larger picture provided by the entity as a whole The dual-track approach isfurther described inside the front cover of this text

Governments may continue to prepare fund-based statements throughout the yearand convert to accrual-based government-wide statements at the end of the year untilthey invest in information systems that can deliver real-time information for decisionmaking We want students to think beyond being transaction-bookkeepers and aspire todesign and use the systems that will make government-wide financial informationavailable when managers and citizens need it The City of Bingham and City ofSmithville Continuous Computerized Problems are teaching tools that develop theseskills and perspective The authors feel so strongly that this general ledger software toolhelps students understand the material that we again provide it with the text Studentshave enthusiastically told us that they like “learning by doing” and that these continuouscomputerized problems helped them to understand the concepts in the book

vi Preface

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public budgeting texts Students in not-for-profit management education programsfind that the coverage of accounting, financial reporting, auditing, taxation, and infor-mation systems for both governmental and not-for-profit entities provides the exposurethey need to work across disciplines and sectors Finally, students preparing for thecertified government financial manager (CGFM) exam will also find Chapters 1through 12 useful for Examination 2 We encourage all students who use this book toconsider the challenges and rewards of careers in public service—in federal, state, andlocal governments as well as not-for-profit organizations.

SUPPLEMENT PACKAGE

The following ancillary materials are prepared by the authors to ensure consistency andaccuracy and are available on the Instructor’s Resource CD-ROM and the textbook’s

Web site, www.mhhe.com/wilson15e.

• Instructor’s Guide and Solutions Manual

• PowerPoint lecture presentations

• Test Bank (including a computerized version using E-Z Test software)

• The City of Bingham and City of Smithville Continuous ComputerizedProblems––general ledger practice sets, downloadable from the publisher’s Web site

• The City of Bingham and City of Smithville Instructor’s Version software, providingguidance for instructors, solution data files, and solution page image (.pdf) files for allrequired financial statements, schedules, and reports

Students can access the PowerPoint lecture presentations, flashcards of key terms, andmultiple-choice practice quizzes for each chapter at the Online Learning Center on the

text’s Web site, www.mhhe.com/wilson15e.

We are thankful for the encouragement, suggestions, and counsel provided by manyinstructors, professionals, and students in writing this book They include the follow-ing professionals and educators who read portions of this book and previous editions

in various forms and provided valuable comments and suggestions:

Las Cruces, New Mexico

Dr Relmond P Van Daniker

Association of Government Accountants

Mr Jay Wahlund

Minot State University

Mr James F White

Harvard Extension School

We acknowledge permission to quote pronouncements and reproduce illustrationsfrom the publications of the Governmental Accounting Standards Board, AmericanInstitute of Certified Public Accountants, International City/County ManagementAssociation, and Crawford and Associates Dr Wilson would like to give specialthanks to his wife, Florence J Wilson, for her patience, support, and understanding incompleting this and several prior editions of the book Dr Reck dedicates the book inmemory of her husband, Albert F Hohenstein

Although we are extremely careful in checking the text and end-of-chaptermaterial, it is possible that errors and ambiguities remain in this edition As readersencounter such, we urge them to let us know so that corrections can be made Wealso invite every user of this edition who has suggestions or comments about thematerial in the chapters to share them with one of the authors, either by regular mail

or e-mail The authors will continue the service of issuing Update Bulletins toadopters of this text that describe changes after the book is in print These bulletinswiL79603_fm_i-xviii.qxd 1/21/09 09:46 PM Page viii

can be downloaded from the text Web site at www.mhhe.com/wilson15e or any of

the authors’ Web sites:

Dr Earl R Wilson School of Accountancy University of Missouri––Columbia

303 Cornell Columbia, MO 65211 wilsonea@missouri.edu http://web.missouri.edu/~wilsonea

Dr Jacqueline L Reck School of Accountancy University of South Florida

4202 East Fowler Avenue, BSN 3403 Tampa, FL 33620

jreck@coba.usf.edu http://www.coba.usf.edu/departments/accounting/ faculty/reck

Dr Susan C Kattelus Department of Accounting and Information Systems Michigan State University

N235 Business College Complex East Lansing, MI 48824

kattelus@msu.edu http://www.msu.edu/~kattelus

Brief Contents

x

Preface v

1 Introduction to Accounting and Financial

Reporting for Governmental and Profit Entities 1

Not-for-PART ONE

2 Principles of Accounting and Financial

Reporting for State and Local Governments 37

3 Governmental Operating Statement

Accounts; Budgetary Accounting 65

4 Accounting for Governmental Operating

Activities—Illustrative Transactions and Financial Statements 111

5 Accounting for General Capital Assets

and Capital Projects 169

6 Accounting for General Long-term

Liabilities and Debt Service 211

7 Accounting for the Business-type

Activities of State and Local Governments 255

8 Accounting for Fiduciary Activities—

Agency and Trust Funds 305

9 Financial Reporting of State and Local

Governments 353

10 Analysis of Governmental Financial

Performance 407

PART TWO

11 Accounting and Reporting for the

NOT-FOR-wiL79603_fm_i-xviii.qxd 1/21/09 09:46 PM Page x

Table of Contents

xi

Preface v Chapter 1 Introduction to Accounting and Financial Reporting for Governmental and Not-for- Profit Entities 1

What Are Governmental and Not-for-Profit Organizations? 2

Distinguishing Characteristics of Governmental andNot-for-Profit Entities 3

Sources of Financial Reporting Standards 4

Determining Whether a Not-for-Profit Organization Is Governmental 5

Objectives of Financial Reporting 6Financial Reporting of State and Local Governments 8

Illustrative Financial Statements—City and County of Denver 9

Major Funds 12 Comprehensive Annual Financial Report 13

Expanding the Scope of Accountability Reporting 14

Overview of Chapters 2 through 17 14

GASB Statement No 34 Principles, Standards, and Financial Reporting 14

Accountability for Public Funds 15 Not-for-Profit Organizations 15

A Caveat 15Appendix: Illustrative Financial Statements—Cityand County of Denver 15

Key Terms 29Questions 29Cases 30Exercises and Problems 31

PART ONE

Chapter 2 Principles of Accounting and Financial Reporting for State and Local

Activities of Government 38Governmental Financial Reporting Entity 38

Integrated Accounting and Financial ReportingModel 39

Government-wide and Fund Financial Statements 40

Fiscal Accountability and Fund Accounting 41 Fund Categories 42

Major Fund Reporting 49

Determination of Major Funds 49 Nonmajor Fund Reporting 50

Appendix: Summary Statement of GovernmentalAccounting and Financial Reporting Principles 52Key Terms 56

Selected References 56Questions 56

Cases 57Exercises and Problems 59

Chapter 3 Governmental Operating Statement

Classification and Reporting of Expenses and Revenues at the Government-wide Level 66

Reporting Direct and Indirect Expenses 66 Program Revenues and General Revenues 68 Reporting Special Items and Transfers 69

Structure and Characteristics of the General Fund;Classification and Description of Operating Statement Accounts 70

Governmental Fund Balance Sheet and Operating Statement Accounts 70

Budgetary Accounts 75Terminology and Classification for GovernmentalFund Budgets and Accounts 78

Classification of Appropriations and Expenditures 78

Classification of Estimated Revenues and Revenues 81

Budgetary Accounting 86

Recording the Budget 87 Budgetary Control of Revenues 88 Budgetary Control of Encumbrances and Expenditures 89

Accounting for Allotments 92 Accounting Information Systems 92

Accounting for Governmental Operating

Activities—Illustrative Transactions and

Illustrative Case 112

Measurement Focus and Basis of Accounting 112

Dual-track Accounting Approach 114

Illustrative Journal Entries 115

Recording the Budget 115

Interfund Transfer to Create a New Fund 115

Encumbrance Entry 117

Payment of Liabilities 119

Payrolls and Payroll Taxes 120

Revenues Recognized as Received in Cash 121

Accounting for Property Taxes 123

Recording Property Tax Levy 123

Collection of Current Taxes 124

Collection of Delinquent Taxes 125

Tax Anticipation Notes Payable 127

Repayment of Tax Anticipation Notes 128

Other Taxes 129

Interim Financial Reporting 129

Special Topics 131

Correction of Errors 131

Receipt of Goods Ordered in Prior Year 131

Revision of the General Fund Budget 133

Internal Exchange Transactions 134

Adjusting Entries 135

Pre-Closing Trial Balance 138

Closing Entries 138

Year-end Financial Statements 140

Special Revenue Funds 143

Accounting for Operating Grants 144

Financial Reporting 144

Interfund Activity 145

Reciprocal Interfund Activity 145

Nonreciprocal Interfund Activity 147

xii Contents

Intra- versus Inter-Activity Transactions (Government-wide Level) 148 Intra-Entity Transactions 148

Permanent Funds 148

Budgetary Accounts 149 Illustrative Case 149

Appendix: Concepts and Rules for Recognition ofRevenues and Expenses (or Expenditures) 153Key Terms 156

Selected References 156Questions 157

Cases 157Exercises and Problems 160

Chapter 5 Accounting for General Capital Assets and

Accounting for General Capital Assets 170

Required Disclosures about Capital Assets 171 Classification of General Capital Assets 172 General Capital Assets Acquired under Capital Lease Agreements 177 Costs Incurred after Acquisition 179 Reduction of Cost 179

Asset Impairments and Insurance Recoveries 180 Illustrative Entries 180

Capital Projects Funds 182

Legal Requirements 183 Illustrative Transactions—Capital Projects Funds 183

Illustrative Financial Statements for a Capital Projects Fund 189

Alternative Treatment of Residual Equity or Deficits 189

Bond Premium, Discount, and Accrued Interest on Bonds Sold 190

Retained Percentages 192 Claims and Judgments Payable 193 Bond Anticipation Notes Payable and the Problem of Interest Expenditures 193

Investments 195 Multiple-Period and Multiple-Project Bond Funds 195

Reestablishment of Encumbrances 196 Capital Projects Financed by Special Assessments 197

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Financial Reporting for Capital Projects Funds 198

Key Terms 199Selected References 199Questions 199

Cases 200Exercises and Problems 201

Chapter 6 Accounting for General Long-term

General Long-term Liabilities 212

Accounting for Long-term Liabilities 212 Pollution Remediation Obligations 213 Long-term Liability Disclosures 214 Debt Limit and Debt Margin 214 Overlapping Debt 215

Debt Service Funds 221

Number of Debt Service Funds 221 Use of General Fund to Account for Debt Service 221

Budgeting for Debt Service 221 Types of Serial Bonds 222 Debt Service Accounting for Term Bonds 228 Financial Reporting 232

Valuation of Debt Service Fund Investments 232 Deposit and Investment Disclosures 235 Debt Service Accounting for Special Assessment Debt 236

Use of Debt Service Funds to Record Capital Lease Payments 238

Accounting for Debt Refunding 239 Advance Refunding of Debt 240

Key Terms 241Selected References 241Questions 241

Cases 242Exercises and Problems 245

Chapter 7 Accounting for the Business-type Activities of

Proprietary Funds 256

Assets Acquired under Lease Agreements 256 Financial Reporting Requirements 257

Internal Service Funds 259

Illustrative Case—Supplies Fund 261 Illustrative Statements Using Supplies Fund 265 External Financial Reporting of Internal Service Funds 267

Internal Service Funds with Manufacturing Activities 268

Internal Service Funds as Financing Devices 269 Dissolution of an Internal Service Fund 270

Enterprise Funds 270Water Utility Funds 272

Current and Accrued Assets 273 Restricted Assets 273

Utility Plant 274 Current Liabilities 274 Liabilities Payable from Restricted Assets 275 Long-term Liabilities 275

Net Assets 275 Illustrative Case—Water Utility Fund 276 Illustrative Statements Using Water Utility Fund 281 External Financial Reporting of Enterprise

Funds 285 Regulatory Accounting Principles (RAP) 285 Accounting for Nonutility Enterprises 286 Accounting for Municipal Solid Waste Landfills 287 Required Segment Information 288

Key Terms 289Selected References 289Questions 289

Cases 290Exercises and Problems 292

Chapter 8 Accounting for Fiduciary Activities—Agency

Agency Funds 306

Agency Fund for Special Assessment Debt Service 306

Tax Agency Funds 307

“Pass-through” Agency Funds 313 Financial Reporting of Agency Funds 314

Trust Funds 314Investment Pools 315

Creation of an Investment Pool 315 Operation of a Cash and Investment Pool 319 Withdrawal of Assets from the Pool 323 Closing Entry 323

Illustrative Financial Statements 324

Private-Purpose Trust Funds 325

Pension Funds 326

Required Financial Reporting for Defined Benefit

Pension Plans 327

Evaluating the Status of a Pension Plan 332

Illustrative Transactions for a Defined Benefit

Pension Plan 332

Employer’s Pension Accounting 334

Employer Recording and Reporting of Pension

Concepts Related to Financial Reporting 353

The Governmental Reporting Entity 354

Defining the Financial Reporting Entity 355

Component Units 356

Reporting by Other Government Organizations 358

Governmental Financial Reports 359

Need for Periodic Reports 359

Interim Financial Reports 359

Annual Financial Reports 360

Preparation of Basic Financial Statements 363

Fund Financial Statements 368

International Accounting Standards 375

Appendix A: Converting Accounting Information

from the Modified Accrual to the Accrual Basis of

Accounting 376

Appendix B: Management’s Discussion and

Analysis (MD&A)—City and County of

Denver 380

xiv Contents

Key Terms 392Selected References 392Questions 392

Cases 393Exercises and Problems 397

Chapter 10 Analysis of Governmental Financial

Analyzing Government-wide Financial Statements 418

Use of Benchmarks to Aid Interpretation 421

Sources of Governmental Financial Data 425 Credit Analyst Models 427

Key Terms 428Selected References 428Questions 428

Cases 429Exercises and Problems 431

PART TWO

Chapter 11 Accounting and Reporting for the Federal

Federal Government Financial Management Structure 448

Comptroller General 450 Secretary of the Treasury 450 Director of the Office of Management and Budget 451

Director of the Congressional Budget Office 451

Generally Accepted Accounting Principles for theFederal Government 451

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Hierarchy of Accounting Principles and Standards 452

Conceptual Framework 453

Concepts Statements 453 Funds Used in Federal Accounting 455

Required Financial Reporting—U.S

Government-wide 456Required Financial Reporting—Government Agencies 458

Management’s Discussion and Analysis 459 Performance Reports 459

Financial Statements 459 Other Accompanying Information 469

Dual-Track Accounting System 469

Illustrative Transactions and Entries 471 Adjusting Entries 476

Illustrative Financial Statements 477

Summary of Accounting and Reporting for FederalGovernment Agencies 481

Key Terms 483Selected References 483Questions 483

Cases 484Exercises and Problems 485

Chapter 12 Auditing of Governmental and Not-for-Profit

Financial Audits by Independent CPAs 494

Generally Accepted Auditing Standards 494 Format of the Audit Report 495

Types of Opinions 497 The Audit Process 498 Materiality for Government Audits 500 Required Supplementary Information 500

Government Auditing Standards 501

Types of Audits and Engagements 502 GAGAS Financial Audits 503 Ethics and Independence 505

Single Audits 507

History of the Single Audit 507 Single Audit Act Amendments of 1996 507 Determining who Must Have a Single Audit 508 Single Audit Requirements 511

Selecting Programs for Audit 512 Reports Required for the Single Audit 514

Other Single Audit Requirements 516 Single Audit Quality 517

Impact of SOX on Governments and Profits 518

Not-for-Best Practices—Audit Committees 518 Best Practices—Internal Controls 518

Key Terms 519Selected References 519Questions 519

Cases 520Exercises and Problems 524

Chapter 13 Budgeting and Performance Measurement 529

Budgeting Process in a State or Local Government 537

Budgeting Governmental Appropriations 537 Budgeting Governmental Revenues 541 Budgeting Capital Expenditures 542 Budgeting Cash Receipts 542 Budgeting Cash Disbursements 543

Managerial Tools to Improve Performance 545

Total Quality Management 545 Customer Relationship Management 546 Service Efforts and Accomplishments (SEA) 547 Activity-based Costing 550

Balanced Scorecards 554

Conclusion 555Appendix: Budget and Cost Issues in GrantAccounting 556

Key Terms 561Selected References 561Questions 561

Cases 562Exercises and Problems 564

Characteristics of the Not-for-Profit Sector 580

GAAP for Nongovernmental NPOs 580

Financial Reporting and Accounting 582

Financial Reporting 582

Accounting for Revenues and Gains 590

Accounting for Expenses 595

Accounting for Assets 597

Financially Interrelated Entities 599

Investments in For-Profit Entities 599

Financially Interrelated NPOs 599

Funds Received as an Intermediary 600

Funds Held in Trust by Others 600

Combinations of NPOs 601

Component Units of Governmental Entities 601

Optional Fund Accounting 602

Illustrative Transactions—Voluntary Health and

Welfare Organizations 603

End-of-the-Year Adjusting Journal Entries 608

End-of-the-Year Reclassification Journal

Not-for-Profit Incorporation Laws 631

Registration, Licenses, and Tax Exemption 632

Lobbying and Political Activity 633

Governance 643

Incorporating Documents 643 Board Membership 643

Benchmarking and Performance Measures 644

Financial Performance Measures 645 Nonfinancial Performance Measures 647

Uniform Policies across States 648

Key Terms 649Selected References 649Questions 650

Cases 650Exercises and Problems 652

Chapter 16 Accounting for Colleges and

Accounting and Reporting Issues 668

Statement of Net Assets or Financial Position 668 Statement of Revenues, Expenses, and Changes in Fund Net Assets 672

Statement of Cash Flows 676 Segment Reporting 676

Illustrative Transactions for Private Colleges andUniversities 676

Adjusting Entries 682 Closing Entries 682

Other Accounting Issues 683

Performance Measures 683 Auditing Colleges and Universities 687 Federal Financial Assistance 687 Related Entities 688

Key Terms 689Selected References 689Questions 689

Cases 689Exercises and Problems 693wiL79603_fm_i-xviii.qxd 01/30/2009 02:09 PM Page xvi

Chapter 17 Accounting for Health Care

Illustrative Case for a Not-for-Profit Health CareOrganization 713

Financial Reporting for a Governmental Health CareOrganization 721

Related Entities 723

Other Accounting Issues 723

Budgeting and Costs 723 Auditing 724

Taxation and Regulatory Issues 724 Prepaid Health Care Plans 725 Continuing Care Retirement Communities 725

Financial and Operational Analysis 725Conclusion 726

Key Terms 727Selected References 727Questions 727

Cases 728Exercises and Problems 730

Governmental and Not-for-Profit

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Introduction to Accounting and Financial Reporting for Governmental and Not-for-Profit Entities

Learning Objectives After studying this chapter, you should be able to:

1 Identify and explain the characteristics that distinguish governmental and not-for-profit entities from for-profit entities.

2 Identify the authoritative bodies responsible for setting financial reporting standards for (1) state and local governments, (2) the federal government, and (3) not-for-profit organizations.

3 Contrast and compare the objectives of financial reporting for (1) state and local governments, (2) the federal government, and (3) not-for-profit organizations.

4 Explain the minimum requirements for general purpose external financial reporting for state and local governments and how they relate to comprehensive annual financial reports.

5 Explain the different objectives, measurement focus, and basis of accounting

of the government-wide financial statements and fund financial statements

of state and local governments.

Welcome to the strange new world of accounting for governmental and not-for-profitorganizations! Initially, you may find it challenging to understand the many newterms and concepts you will need to learn Moreover, if you are like most readers,you will question at the outset why governmental and not-for-profit organizationsfind it necessary to use accounting practices that are very different from those used

by for-profit entities

As you read this first chapter of the text, the reasons for the marked differencesbetween governmental and not-for-profit accounting and for-profit accounting

Chapter One

should become apparent Specifically, governmental and not-for-profit tions serve entirely different purposes in society than do business entities Fur-thermore, because such organizations are largely financed by taxpayers, donors,and others who do not expect benefits proportional to the resources they provide,management has a special duty to be accountable for how those resources are used

organiza-in providorganiza-ing services Thus, the need to report on management’s accountability tocitizens, creditors, oversight bodies, and others has played a central role in shap-ing the accounting and reporting practices of governmental and not-for-profitorganizations

This first chapter will give you a basic conceptual foundation for understandingthe unique characteristics of these organizations and how their accounting and finan-cial reporting concepts and practices differ from those of for-profit organizations

By the time you finish subsequent chapters assigned for your course, you shouldhave an in-depth practical knowledge of governmental and not-for-profit accountingand financial reporting

WHAT ARE GOVERNMENTAL AND

NOT-FOR-PROFIT ORGANIZATIONS?

Governmental and not-for-profit organizations are vast in number and range of vices provided In the United States, governments exist at the federal, state, andlocal levels and serve a wide variety of functions The most recent census of gov-ernments reports 89,476 local governmental units, in addition to the federal govern-ment and 50 state governments These 89,476 local governments consist of 3,033counties, 19,492 municipalities, 16,519 towns and townships, 13,051 independentschool districts, and 37,381 special district governments that derive their power fromstate governments.1

ser-States, counties, municipalities (for example, cities and villages), and townshipsare general purpose governments—governments that provide many categories

of services to their residents (such as police and fire protection; sanitation; struction and maintenance of streets, roads, and bridges; and health and welfare).Independent school districts, public colleges and universities, and special districtsare special purpose governments—governments that provide only a single func-tion or a limited number of functions (such as education, drainage and flood con-trol, irrigation, soil and water conservation, fire protection, and water supply).Special purpose governments have the power to levy and collect taxes and to raiserevenues from other sources as provided by state laws to finance the services theyprovide

con-Not-for-profit organizations also exist in many forms and serve many differentfunctions These include private colleges and universities, various kinds of healthcare organizations, certain libraries and museums, professional and trade associa-tions, fraternal and social organizations, and religious organizations Currently, thereare nearly 2 million not-for-profit organizations in the U.S.2

2 Accounting for Governmental and Nonprofit Entities

1 U.S Department of Commerce, Bureau of the Census, 2007 Census of Governments, vol 1, no 1

(Washington, DC: U.S Government Printing Office), p v.

2 The Independent Sector and Urban Institute estimate that there are about 1.8 million organizations in

the not-for-profit sector (Urban Institute, The New Nonprofit Almanac & Desk Reference, Washington,

D.C., 2007).

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DISTINGUISHING CHARACTERISTICS OF GOVERNMENTAL AND NOT-FOR-PROFIT ENTITIES

Governmental and not-for-profit organizations differ in important ways from businessorganizations Not surprisingly then, accounting and financial reporting for govern-mental and not-for-profit organizations are markedly different from accounting andfinancial reporting for businesses An understanding of how these organizations differfrom business organizations is essential to understanding the unique accounting andfinancial reporting principles that have evolved for governmental and not-for-profitorganizations

In its Statement of Financial Accounting Concepts No 4, the Financial

Account-ing Standards Board (FASB) noted the following characteristics that it felt guished governmental and not-for-profit entities from business organizations:

distin-a Receipts of significant amounts of resources from resource providers who do

not expect to receive either repayment or economic benefits proportionate tothe resources provided

b Operating purposes that are other than to provide goods or services at a profit

or profit equivalent

c Absence of defined ownership interests that can be sold, transferred, or

redeemed, or that convey entitlement to a share of a residual distribution ofresources in the event of liquidation of the organization.3

The Governmental Accounting Standards Board (GASB) distinguishes ernmental entities in the United States from not-for-profit entities and from businesses

gov-by stressing that governments exist in an environment in which the power ultimatelyrests in the hands of the people Voters delegate that power to public officials throughthe election process The power is divided among the executive, legislative, andjudicial branches of the government so that the actions, financial and otherwise, ofgovernmental executives are constrained by legislative actions, and executive and leg-islative actions are subject to judicial review Further constraints are imposed on stateand local governments by the existence of the federal system in which higher levels

of government encourage or dictate activities by lower levels and finance the ties (partially, at least) by an extensive system of intergovernmental grants and sub-sidies that require the lower levels to be accountable to the entity providing theresources, as well as to the citizenry Revenues raised by each level of governmentcome, ultimately, from taxpayers Taxpayers are required to serve as providers ofresources to governments even though they often have very little choice about whichgovernmental services they receive and the extent to which they receive them.4

activi-In the GASB’s view, accounting and financial reporting standards for governmentsmust be separate and distinct from those for business organizations because the needs

of users of financial reports are unique and different This view is clear from a recent

3 Financial Accounting Standards Board, Statement of Financial Accounting Concepts No 4, “Objectives

of Financial Reporting by Nonbusiness Organizations” (Norwalk, CT, 1980), p 3 In 1985 the FASB

replaced the term nonbusiness with the term not-for-profit Other organizations use the term nonprofit

as a synonym for not-for-profit The term not-for-profit is predominantly used in this text.

4 Based on discussion in GASB Concepts Statement No 1, pars 14–18 Governmental Accounting Standards Board, Codification of Governmental Accounting and Financial Reporting Standards as of

June 30, 2008 (Norwalk, CT, 2008), Appendix B.

GASB white paper which notes that “governments do not operate in a competitivemarketplace, face virtually no threat of liquidation, and do not have equity owners.”5

Consequently, governmental financial reporting focuses on a government’s ship of public resources, ongoing ability to raise taxes and manage resources, andcompliance with legal spending limits, rather than on information about earnings.More specifically, the white paper states:

steward-Governmental accounting and financial reporting standards aim to address [the] need forpublic accountability information by helping stakeholders assess how public resources areacquired and used, whether current resources were sufficient to meet current service costs

or whether some costs were shifted to future taxpayers, and whether the government’sability to provide services improved or deteriorated from the previous year.6

SOURCES OF FINANCIAL REPORTING STANDARDS

Illustration 1–1 shows the primary sources of accounting and financial reportingstandards for business and not-for-profit organizations, state and local governments,and the federal government Specifically, the FASB sets standards for for-profit busi-ness organizations and nongovernmental not-for-profit organizations; the GASB setsstandards for state and local governments, including governmental not-for-profitorganizations; and the Federal Accounting Standards Advisory Board (FASAB) setsstandards for the federal government and its agencies and departments

Authority to establish accounting and reporting standards for not-for-profit nizations is split between the FASB and the GASB because a sizeable number of

orga-4 Accounting for Governmental and Nonprofit Entities

5 Governmental Accounting Standards Board, White Paper “Why Governmental Accounting and

Financial Reporting Is — and Should Be—Different” (Norwalk, CT, 2006), Executive Summary, pp 1–2.

6 Ibid.

Financial Accounting Foundation

Financial Accounting Standards Board (FASB)

Business

(for-profit)

organizations

Nongovernmental not-for-profit organizations

State and local governmental organizations

Governmental not-for-profit organizations

Federal government and its agencies and departments

Governmental Accounting Standards Board (GASB)

Federal Accounting Standards Advisory Board (FASAB)

• Comptroller General

• Director of the Office of Management and Budget

• Secretary of the Treasury

ILLUSTRATION 1–1 Primary Sources of Accounting and Financial Reporting Standards for Businesses,

Governments, and Not-for-Profit Organizations

Source: Statement on Auditing Standards (SAS) 69, amended by SAS 91, April 2000, AICPA Professional Standards, as of June 1, 2008, v.1, Au Sec 411.

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not-for-profit organizations are governmentally owned, particularly public collegesand universities and government hospitals The FASB is responsible for settingaccounting and reporting standards for the great majority of not-for-profit organiza-tions, those that are independent of governments Governmental not-for-profit orga-nizations follow standards established by the GASB.

The GASB and the FASB are parallel bodies under the oversight of the FinancialAccounting Foundation The foundation appoints the members of the two boards andsupports the boards’ operations The federal Sarbanes-Oxley Act greatly enhanced finan-cial support for the FASB by mandating an assessed fee on corporate security offerings.The GASB, on the other hand, relies mainly on contributions from state and local gov-ernment organizations and sales of publications for financial support of its operations.Because of the breadth of support and the lack of ties to any single organization

or governmental unit, the GASB and the FASB are referred to as “independentstandards-setting boards in the private sector.” Before the creation of the GASB andthe FASB, financial reporting standards were set by groups sponsored by profes-sional organizations: The forerunners of the GASB (formed in 1984) were theNational Council on Governmental Accounting (1973–84), the National Committee

on Governmental Accounting (1948–73), and the National Committee on MunicipalAccounting (1934–41) The forerunners of the FASB (formed in 1973) were theAccounting Principles Board (1959–73) and the Committee on Accounting Procedure(1938–59) of the American Institute of Certified Public Accountants

Federal statutes assign responsibility for establishing and maintaining a soundfinancial structure for the federal government to three officials: the Comptroller Gen-eral, the Director of the Office of Management and Budget, and the Secretary of theTreasury In 1990, these three officials created the Federal Accounting Standards

Advisory Board (FASAB) to recommend accounting principles and standards forthe federal government and its agencies It is understood that, to the maximum extentpossible, federal accounting and financial reporting standards should be consistentwith those established by the GASB and, where applicable, by the FASB

In Rule 203 of its Code of Professional Conduct, the American Institute of tified Public Accountants (AICPA) has formally designated the GASB, the FASAB,and the FASB as the authoritative bodies to establish generally accepted accounting

Cer-principles (GAAP) for state and local governments, the federal government, andbusiness organizations and nongovernmental not-for-profit organizations, respectively

“Authority to establish accounting principles” is interpreted in practice to mean

“authority to establish accounting and financial reporting standards.”7

Determining Whether a Not-for-Profit Organization

Is Governmental

Illustration 1–1 suggests that the kinds of organizations for which the FASB and GASBare responsible for setting standards are clearcut Unfortunately, this is sometimes notthe case In practice, it may be difficult to determine whether some not-for-profits aregovernmental in nature or not, and thus which standards-setting body to look to forauthoritative guidance

7 Statement on Auditing Standards (SAS) 69, as amended by SAS 91, April 2000, specifically establishes

the FASB, the GASB, and the FASAB as the bodies to establish GAAP for their respective organizations Other literature, such as AICPA Audit and Accounting Guides, are afforded secondary status as sources

of authoritative guidance These sources are discussed more fully in the “GAAP Hierarchy” section of Chapter 12.

The U.S Bureau of the Census defines a government as:

An organized entity which, in addition to having governmental character, has sufficientdiscretion in the management of its own affairs to distinguish it as separate from theadministrative structure of any other governmental unit.8

This definition, though helpful, provides insufficient guidance because it fails toexplain the meaning of “having governmental character.” In order to provide addi-tional guidance for auditors on this issue, two audit and accounting guides of theAICPA, with the tacit approval of both the FASB and the GASB, state:

Public corporations and bodies corporate and politic are governmental organizations.Other organizations are governmental organizations if they have one or more of thefollowing characteristics:

a Popular election of officers or appointment (or approval) of a controlling majority

of the members of the organization’s governing body by officials of one or morestate or local governments,

b the potential for unilateral dissolution by a government with the net assets reverting

to a government, or

c the power to enact and enforce a tax levy.9

Furthermore, organizations are presumed to be governmental if they have theability to issue directly (rather than through a state or municipal authority) debt thatpays interest exempt from federal taxation However, organizations possessing onlythat ability (to issue tax-exempt debt) and none of the other governmental charac-teristics may rebut the presumption that they are governmental if their determination

is supported by compelling, relevant evidence Colleges and universities, hospitals,museums, and social service agencies are examples of organizations that may beeither governmental or nongovernmental

OBJECTIVES OF FINANCIAL REPORTING

GASB Concepts Statement No 1, “Objectives of Financial Reporting,” states that

“Accountability is the cornerstone of all financial reporting in government .Accountability requires governments to answer to the citizenry—to justify the rais-ing of public resources and the purposes for which they are used.”10 The boardelaborated:

Governmental accountability is based on the belief that the citizenry has a “right toknow,” a right to receive openly declared facts that may lead to public debate by thecitizens and their elected representatives Financial reporting plays a major role infulfilling government’s duty to be publicly accountable in a democratic society.11

Illustration 1–2 shows several ways that state and local governmental financialreporting is used in making economic, social, and political decisions and assessingaccountability Closely related to the concept of accountability as the cornerstone of

6 Accounting for Governmental and Nonprofit Entities

8 U.S Department of Commerce, Bureau of the Census, 2007 Census of Governments, p ix.

9 American Institute of Certified Public Accountants, Audit and Accounting Guide, Health Care

Organizations (New York, 2007), par 1.02c; and American Institute of Certified Public Accountants,

Audit and Accounting Guide, Not-for-Profit Organizations (New York, 2008), par 1.03.

10 GASB, Codification, Appendix B, Concepts Statement No 1, par 56.

11 Ibid.

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governmental financial reporting is the concept the GASB refers to as interperiod

equity The concept and its importance are explained as follows:

The Board believes that interperiod equity is a significant part of accountability and isfundamental to public administration It therefore needs to be considered when

establishing financial reporting objectives In short, financial reporting should help users assess whether current-year revenues are sufficient to pay for services provided that year and whether future taxpayers will be required to assume burdens for services previously provided (Emphasis added.)12

Accountability is also the foundation for the financial reporting objectives the

FASAB has established for the federal government The FASAB’s Statement of

Accounting and Reporting Concepts Statement No 1 identifies four objectives of

federal financial reporting (see Illustration 1–2) focused on evaluating budgetaryintegrity, operating performance, stewardship, and adequacy of systems and controls

Unlike the FASB and the GASB, which focus their standards on external financial

reporting, the FASAB and its sponsors in the federal government are concerned with

both internal and external financial reporting Accordingly, the FASAB has

identi-fied four major groups of users of federal financial reports: citizens, Congress, utives, and program managers Given the broad role the FASAB has been assigned,its standards focus on cost accounting and service efforts and accomplishment mea-sures, as well as on financial accounting and reporting

exec-Financial reports of not-for-profit organizations—voluntary health and welfareorganizations, private colleges and universities, private health care institutions, religiousorganizations, and others—have similar uses However, as Illustration 1–2 shows, thereporting objectives for not-for-profit organizations emphasize decision usefulnessover financial accountability needs, presumably reflecting the fact that the financialoperations of not-for-profit organizations—as compared to those of governments—are generally subject to less detailed legal restrictions

12 Ibid., par 61.

ILLUSTRATION 1–2 Comparison of Financial Reporting Objectives—State and Local Governments, Federal

Government, and Not-for-Profit Organizations

aSource: GASB Concepts Statement No 1, par 32.

bSource: FASAB Statement of Federal Accounting Concepts No 1, par 134.

cSource: FASB Concepts Statement No 4, pp 19–23.

State and Local Governments a

Financial reporting is used in making economic, social, and political decisions and in assessing accountability primarily by:

• Comparing actual financial results with the legally adopted budget.

• Assessing financial condition and results of operations.

• Assisting in determining compliance with finance-related laws, rules, and regulations.

• Assisting in evaluating efficiency and effectiveness.

• Making resource allocation decisions.

• Assessing services and ability to provide services.

• Assessing management stewardship and performance.

• Assessing economic resources, obligations, net resources, and changes in them.

Note that the objectives of financial reporting for governments and not-for-profitentities stress the need for the public to understand and evaluate the financial activitiesand management of these organizations Readers will recognize the impact on theirlives, and on their bank accounts, of the activities of the layers of government theyare obligated to support and of the not-for-profit organizations they voluntarily sup-port Since each of us is significantly affected, it is important that we be able to readintelligently the financial reports of governmental and not-for-profit entities In order

to make informed decisions as citizens, taxpayers, creditors, and donors, readersshould make the effort to learn the accounting and financial reporting standardsdeveloped by the authoritative bodies The standards are further explained and illus-trated throughout the remainder of the text

FINANCIAL REPORTING OF STATE AND LOCAL GOVERNMENTS

Like the FASB, the GASB continues to develop concepts statements that cate the framework within which the Board strives to establish consistent financialreporting standards for entities within its jurisdiction The GASB, as well as the

communi-FASB, is concerned with establishing standards for financial reporting to external

users—those who lack the authority to prescribe the information they want and whomust rely on the information management communicates to them The Board doesnot intend to set standards for reporting to managers and administrators or othersdeemed to have the ability to enforce their demands for information

Illustration 1–3 displays the minimum requirements for general purpose externalfinancial reporting under the governmental financial reporting model specified by

GASB Statement No 34 (GASBS 34).13Central to the model is the management’s

discussion and analysis (MD&A). The MD&A is required supplementary

information (RSI)designed to communicate in narrative, easily readable form thepurpose of the basic financial statements and the government’s current financialposition and results of financial activities compared with those of the prior year

As shown in Illustration 1–3, GASBS 34 prescribes two categories of basic

finan-cial statements, government-wide and fund Government-wide financial

state-mentsare intended to provide an aggregated overview of a government’s net assets andchanges in net assets The government-wide financial statements report on the govern-ment as a whole and assist in assessing operational accountability—whether the gov-ernment has used its resources efficiently and effectively in meeting operating objectives.The GASB concluded that reporting on operational accountability is best achieved byusing essentially the same basis of accounting and measurement focus used by businessorganizations: the accrual basis and flow of economic resources measurement focus

Fund financial statements, the other category of basic financial statements,assist in assessing whether the government has raised and spent financial resources

in accordance with budget plans and in compliance with pertinent laws and

regula-tions Certain funds, referred to as governmental funds, focus on the short-term flow

of current financial resources or fiscal accountability, rather than on the flow ofeconomic resources.14 Other funds, referred to as proprietary and fiduciary funds,

8 Accounting for Governmental and Nonprofit Entities

13 GASB Statement No 34, “Basic Financial Statements—and Management’s Discussion and Analysis— for State and Local Governments” (Norwalk, CT, 1999) Hereafter, Statement No 34 is abbreviated as

GASBS 34.

14 The definition of fund is given in Chapter 2 For now, you can view a fund as a separate set of

accounts used to account for resources segregated for particular purposes.

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account for the business-type and certain fiduciary activities of the government.These funds follow accounting and reporting principles similar to those of businessorganizations, although a number of GASB standards applicable to these fundsdiffer substantially from FASB standards applicable to business organizations.These differences will be discussed in later chapters.

As shown in Illustration 1–3, the notes to the financial statements are consideredintegral to the financial statements In addition, governments are required to disclosecertain RSI other than MD&A These additional information disclosures are discussed

in several of the following chapters

Illustrative Financial Statements—City and County of Denver

As mentioned at the beginning of this chapter, governmental financial reporting hasevolved to meet the unique needs of citizens and other financial statement users Itshould not be surprising that these financial statements are quite different from thoseprepared by business organizations Real-world examples of local government finan-cial statements—the basic financial statements of the combined City and Countygovernment of Denver, Colorado—are provided as Illustrations A1–1 through A1–11

in the appendix to this chapter These statements should be referred to frequentlywhile studying Chapters 1 through 9 of the text.15Denver’s basic financial statements

are those specified by GASBS 34 and consist of:

Government-wide Financial Statements

1 Statement of net assets (see Illustration A1–1)

2 Statement of activities (see Illustration A1–2)

15 The City and County of Denver’s financial statements provided in Chapter 1, and various required and other supplementary information that are presented in later chapters, are intended for illustrative educa- tional purposes only Omitted in this text are the auditor’s report on the financial statements, the notes to the financial statements, and other required supplementary information Moreover, depending on the time since this text was released, more current financial statements may be available Those who have a need for financial information for credit analysis or other evaluative or decision purposes should refer to the City and County of Denver’s audited financial statements in the comprehensive annual financial report.

ILLUSTRATION 1–3 Minimum Requirements for General Purpose External Financial

Reporting—GASB Statement No 34 Reporting Model

Source: GASB Codification, Sec 2200.103.

Management's discussion and analysis

Notes to the financial statements

Required supplementary information (other than MD&A)

Government-wide financial statements

Fund financial statements

Fund Financial Statements

1 Balance sheet—governmental funds (see Illustration A1–3)

2 Statement of revenues, expenditures, and changes in fund balances—governmentalfunds (see Illustration A1–5)

3 Statement of net assets—proprietary funds (see Illustration A1–7)

4 Statement of revenues, expenses, and changes in fund net assets—proprietary funds(see Illustration A1–8)

5 Statement of cash flows—proprietary funds (see Illustration A1–9)

6 Statement of fiduciary net assets (see Illustration A1–10)

7 Statement of changes in fiduciary net assets (see Illustration A1–11)

Government-wide Financial Statements

Denver’s government-wide financial statements (see Illustrations A1–1 and A1–2)

follow the GASBS 34 recommended formats; financial information is presented in

separate columns for governmental activities and business-type activities of theprimary government and its discretely presented component units (i.e., legally separateorganizations for which the City and County of Denver is deemed financiallyaccountable) Governmental and business-type activities are discussed in Chapter 2.Essentially, governmental activities encompass the executive, legislative, and judicialfunctions of the government as well as major service functions such as public safety,public works, parks and recreation, health and human services, and cultural activities.Business-type activities are largely self-supporting activities of a government thatprovide services to the public for a fee Typical examples are electric, sewer, andwater utilities; transportation systems; airports; toll roads and bridges; and parkingfacilities

Because the financial statements display information in multiple columns, theyare not fully consolidated in the manner of corporate financial statements Receiv-ables and payables between activities reported in the same activities column orbetween component units are eliminated in preparing the financial statements.However, receivables/payables between activities reported in different columns arenot eliminated For example, Denver’s statement of net assets shows a receivable

of $23,625 under the line item internal balances in the Governmental Activities

column with an equal contra-asset (payable) in the Business-type Activities

col-umn These two amounts represent the net receivables and payables between these

two activity categories

As mentioned earlier and discussed more fully in Chapter 2, the two

government-wide financial statements are intended to report on the government’s operational

accountability As such, the government-wide financial statements are prepared using

essentially the same basis of accounting and measurement focus that are used inbusiness accounting—that is, the accrual basis of accounting and measurement oftotal economic resources

Fund Financial Statements

By contrast, governmental fund financial statements (see Illustrations A1–3 and

A1–5) report on fiscal accountability Therefore, these statements report only

information that is useful in assessing whether financial resources were raised andexpended in compliance with budgetary and other legal provisions Thus, govern-mental fund statements focus on the flow of current financial resources—cash and

10 Accounting for Governmental and Nonprofit Entities

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near-cash resources that are available for expenditure Since long-term obligations

do not have to be paid in the current budgetary period, nor do noncurrent assets such

as land, buildings, and equipment provide resources to pay current period obligations,neither is reported in the governmental funds Both are reported in the GovernmentalActivities column of the government-wide statement of net assets, however, as shown

in Illustration A1–1

Modified accrual is the basis of accounting that has evolved for governmental

funds Under this basis, revenues are recorded only if they are measurable and able for paying current period obligations Expenditures are generally recognizedwhen incurred As shown in Illustration A1–5, the governmental fund statement ofrevenues, expenditures, and changes in fund balances reports expenditures, sinceoutlays to acquire goods or services are more relevant than expenses in measuringthe outflow of current financial resources Expenses, however, are more relevant atthe government-wide level, as they measure the cost of services provided Conse-quently, expenses, classified by program or function, are reported for both govern-mental and business-type activities, as shown in Denver’s statement of activities (seeIllustration A1–2)

avail-Illustration 1–4 summarizes key aspects of the dual roles that governmentalfinancial statements serve Readers may be confused by the fact that the sameunderlying financial information for governmental activities is reported in two dif-ferent ways: (1) using accrual basis accounting with an economic resources mea-surement focus in the government-wide financial statements and (2) usingmodified accrual basis accounting with a current financial resources focus in thefund statements To ensure integration of these statements, GASB standards requirethat the total fund balances reported on the balance sheet—governmental funds(Illustration A1–3) be reconciled to total governmental activities net assets reported

in the statement of net assets (Illustration A1–1) The reconciliation can be played on the face of the balance sheet—governmental funds or, as Denver hasdone, separately as a stand-alone schedule (see Illustration A1–4) Similarly, GASBrequires that operating (change) statement results be reconciled for governmentalactivities Accordingly, Denver presents a reconciliation (see Illustration A1–6) ofthe net changes in fund balances—total governmental funds reported on its state-ment of revenues, expenditures, and changes in fund balances—governmental

dis-ILLUSTRATION 1–4 Dual Roles of Governmental Financial Statements in Assessing Accountability

Statements

Measurement focus Basis of accounting

Operational Accountability

Government-wide financial statements (governmental and business-type activi- ties) and those of proprietary funds and fiduciary funds

Flow of economic resources

Accrual basis (revenues and expenses

are recognized when exchange of economic resources occurs or per GASB recognition rules for nonex- change transactions, such as taxes, contributions, and grants)

Fiscal Accountability

Governmental fund financial statements

Flow of current financial resources Modified accrual basis (revenues are recognized when resources are measurable and available for current

spending; expenditures are recognized

when an obligation to spend current financial resources is incurred)

funds (Illustration A1–5) to the change in net assets of governmental activitiesreported on its statement of activities (Illustration A1–2) For now, it is sufficient

to just be aware that such reconciliations are required; you will learn to preparereconciliations later in the text

Proprietary fund financial statements present financial information for enterprisefunds and internal service funds Both types of funds operate essentially as self-sup-porting entities and, therefore, follow accounting and reporting practices similar tothose of business organizations Enterprise funds and internal service funds aredistinguished primarily by the kinds of customers they serve Enterprise funds providegoods or services to the public, whereas internal service funds mainly serve depart-ments of the same government For most governments, the information reported inthe Business-type Activities column of the government-wide statements is simplythe total of all enterprise funds information Because internal service funds predom-inantly serve governmental activities, financial information for internal servicefunds is typically reported in the Governmental Activities column at the govern-ment-wide level

As required by GASB standards, the City and County of Denver reports prietary funds financial information in three financial statements: a statement ofnet assets—proprietary funds (Illustration A1–7), a statement of revenues,expenses, and changes in fund net assets—proprietary funds (Illustration A1–8),and a statement of cash flows—proprietary funds (Illustration A1–9) An astutereader will note that these are very similar to the three financial statementsrequired for business organizations, although there are important differences, aswill be discussed in later chapters

pro-The final two required financial statements are those for the fiduciary funds Bydefinition, fiduciary funds account for resources that the government is holding ormanaging for an external party, that is, an individual, organization, or other govern-ment Because these resources may not be used to support the government’s ownprograms, GASB standards require that financial information about fiduciary activ-ities be omitted from the government-wide financial statements; however, the infor-mation must be reported in two fund financial statements: a statement of fiduciarynet assets—fiduciary funds and a statement of changes in fiduciary net assets—fidu-ciary funds Both statements are prepared using accrual accounting with the eco-nomic resources measurement focus These two statements for the City and County

of Denver are presented in Illustrations A1–10 and A1–11

Major Funds

Both governmental funds and proprietary funds financial statements must provideseparate columns for each major fund(see Chapter 2 for the definition of a majorfund) The aggregate of nonmajor governmental and enterprise funds is reported in

a single column of the corresponding statements In addition to the General Fund,which is always considered a major fund, Denver identifies its Human Services andBond Projects funds as major governmental funds (Illustration A1–3) and its Waste-water Management and Denver Airport System funds as major enterprise funds(Illustration A1–7) Major fund reporting is not applicable to internal service funds

fund To meet the needs of individuals having an interest in particular nonmajor funds,

governments should provide separate combining financial statements for nonmajor ernmental and proprietary funds, as well as for discretely presented component units

gov-Comprehensive Annual Financial Report

Serious users of governmental financial information need more detail than is found

in the MD&A, basic financial statements, and RSI (other than MD&A) For stateand local governments, much of that detail is found in the governmental reportingentity’s comprehensive annual financial report (CAFR). Although governmentsare not required to prepare a CAFR, most do so as a matter of public record and toprovide additional financial details beyond the minimum requirements shown inIllustration 1–3 As such, the GASB provides standards for the content of a CAFR

in its annually updated publication Codification of Governmental Accounting and

Financial Reporting Standards A CAFR prepared in conformity with these standards

should contain the following sections.16

Introductory Section 17

The introductory section typically includes items such as a title page and contentspage, a letter of transmittal, a description of the government, and other items deemedappropriate by management The letter of transmittal may be literally that—a letterfrom the chief financial officer addressed to the chief executive and governing body

of the government—or it may be a narrative over the signature of the chief executive

In either event, the letter or narrative material should cite legal and policy ments for the report

require-Financial Section

The financial section of a comprehensive annual financial report should include(1) an auditor’s report, (2) management’s discussion and analysis (MD&A), (3) basicfinancial statements, (4) required supplementary information (other than MD&A),and (5) other supplementary information, such as combining statements and indi-vidual fund statements and schedules Items (2), (3), and (4) represent the minimumrequirements for general purpose external financial reporting, as depicted in Illus-tration 1–3 So, it should be apparent that a CAFR provides additional supplemen-tary financial information beyond the minimum amount required by generallyaccepted accounting principles

Laws regarding the audit of governments vary from state to state Some stateshave laws requiring that all state agencies and all local governments be audited by

an audit agency of the state government In other states, local governments areaudited by independent public accounting firms In still other states, some local gov-ernments are audited by the state audit agency and some by independent publicaccounting firms In any event, the auditor’s opinion should accompany the financialstatements reproduced in the report

16 GASB, Codification, Sec 2200.104–193.

17 For a view of the introductory section, as well as the other sections of the CAFR, you may wish to

look at the City and County of Denver, Colorado’s CAFR at http://www.denvergov.org/controller/ Click

on “Financial Reports.” Portions of Denver’s CAFR for 2007 are included for illustrative purposes in various places in this text.

The financial section should contain sufficient information to disclose fully andpresent fairly the financial position and results of financial operations during thefiscal year Laws of higher jurisdictions, actions of the legislative branch of thegovernment itself, and agreements with creditors and others impose constraintsover governments’ financial activities and create unique financial accountabilityrequirements.

Statistical Section

In addition to the introductory and financial sections of the CAFR, which were justdescribed, a CAFR should contain a statistical section The statistical section typi-cally presents tables and charts showing demographic and economic data, financialtrends, fiscal capacity, and operating information of the government in the detailneeded by readers who are more than casually interested in the activities of the

government The GASB Codification suggests the content of the statistical tables

usually considered necessary for inclusion in a CAFR The statistical section isdiscussed at greater length in Chapter 9 of this text

EXPANDING THE SCOPE OF ACCOUNTABILITY REPORTING

Some governments publish highly condensed popular reports These reports usuallycontain selected data from the audited financial statements, statistical data, graphicdisplays, and narrative explanations, but the reports themselves are not audited Inaddition, many state and local governments have begun to identify and report non-financial performance measures For more than a decade, the GASB has encouragedstate and local governments to experiment with reporting service efforts and

accomplishments (SEA) measures to provide more complete information about agovernmental entity’s performance than can be provided by basic financial state-ments, budgetary comparison statements, and schedules Indicators of service effortsinclude inputs of nonmonetary resources as well as inputs of dollars Indicators ofservice accomplishments include both outputs and outcomes; outputs are quantita-tive measures of work done, such as the number of juvenile cases handled, and out-comes are the impacts of outputs on program objectives, such as a reduction in thehigh school dropout rate or incidence of juvenile crime Chapter 13 provides addi-tional discussion of SEA measures

OVERVIEW OF CHAPTERS 2 THROUGH 17

GASB Principles, Standards, and Financial Reporting

Part 1 of the text (Chapters 2–10) focuses on state and local governments The ciples that underlie GASB accounting and reporting standards are presented in Chap-ter 2 Chapters 3 through 8 provide detailed illustrations of the effect of financialtransactions on the funds and government-wide statements Financial reporting forstate and local governments, as seen in the City and County of Denver, Colorado’sstatements presented in the appendix to this chapter, is described in detail in Chap-ter 9 Analysis of the financial performance of state and local governments based onfinancial and other information is described in Chapter 10

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Accountability for Public Funds

Part II of the text includes three chapters that describe ways that public financialmanagers provide accountability over funds entrusted to them Chapter 11 focuses

on the federal government, the largest provider of public funds, and introduces federaloffices that interact with state and local governments and not-for-profit organizations

in a variety of ways; for example, the Government Accountability Office (GAO) andthe Office of Management and Budget (OMB) Auditing techniques designed toassure the public that funds are properly accounted for and spent efficiently andeffectively are described in Chapter 12, with special attention devoted to areas ofauditing that are unique to federal funds, such as single audits Chapter 13 coverstools important to managers in demonstrating accountability for funds, such as bud-geting, costing, and performance measurement

Not-for-Profit Organizations

Part III is a set of four chapters covering the unique accounting and financial ing issues facing entities in the not-for-profit sector Chapter 14 provides detailedillustrations of the effect of financial transactions on the financial statements of not-for-profit organizations, much like Chapter 3 through 8 does for state and local gov-ernments The governance and regulatory issues that a not-for-profit organizationfaces from the time of its incorporation through merger or dissolution, if any, arepresented in Chapter 15 Chapters 16 and 17 present industry-specific accountingand financial reporting requirements for colleges and universities and health careorganizations, respectively

report-A Creport-AVEreport-AT

The first edition of this text was written by the late Professor R M Mikesell morethan 55 years ago in 1951 Some words of his bear thoughtful rereading from time totime by teachers and students in all fields, not just those concerned with accountingand financial reporting for governmental and not-for-profit entities:

Even when developed to the ultimate stage of perfection, governmental accountingcannot become a guaranty of good government At best, it can never be more than avaluable tool for promotion of sound financial management It does not offer a panaceafor all the ills that beset representative government; nor will it fully overcome theinfluence of disinterested, uninformed citizens It cannot be substituted for honesty andmoral integrity on the part of public officials; it can help in resisting but cannot eliminatethe demands of selfish interests, whether in the form of individual citizens, corporations,

or the pressure groups which always abound to influence government at all levels.18

18 R M Mikesell, Governmental Accounting, rev ed., Homewood, IL: Richard D Irwin, 1956, p 10.

Appendix

Illustrative Financial Statements—City and County

of Denver

CITY AND COUNTY OF DENVER Statement of Net Assets December 31, 2007 (amounts expressed in thousands)

Primary Government

Buildings, improvements, infrastructure, collections, 1,858,521 3,399,042 5,257,563 1,594,557

and equipment, net of accumulated depreciation

Noncurrent liabilities:

CITY AND COUNTY OF DENVER

Balance Sheet Governmental Funds December 31, 2007 (amounts expressed in thousands)

Other Total

Assets

Receivables (net of allowances of $71,799)

Restricted assets:

Designated for subsequent years’

expenditures, reported in:

Undesignated, reported in:

ILLUSTRATION A1–3

18 Accounting for Governmental and Nonprofit Entities

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Amounts reported for governmental activities in the statement of net assets are different because:

Capital assets used in governmental activities, excluding internal 2,202,429 service funds of $4,102, are not financial resources, and therefore,

are not reported in the funds.

Accrued interest payable not included in the funds (13,921) Other long-term assets are not available to pay for current-period 26,050 expenditures and,therefore, are deferred in the funds.

Bond issue costs, net of accumulated amortization 3,850 Internal service funds are used by management to charge (4,219) the cost of these funds to their primary users—governmental funds

The assets and liabilities of the internal service funds are included in governmental activities in the statement of net assets.

Long-term liabilities, including bonds payable, are not due and (1,304,973) payable in the current period and therefore are not reported in

the governmental funds (this excludes internal service liabilities of $34,001).

ILLUSTRATION A1–5

CITY AND COUNTY OF DENVER Statement of Revenues, Expenditures, and Changes in Fund Balance

Governmental Funds For the year ended December 31, 2007 (amounts expressed in thousands)

Other Total

Excess (Deficiency) of revenues over expenditures 21,751 (3,608) (48,925) (38,070) (68,852)

Other Financing Sources (Uses)

20 Accounting for Governmental and Nonprofit Entities

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ILLUSTRATION A1–6

CITY AND COUNTY OF DENVER Reconciliation of the Statement of Revenues, Expenditures, and Changes in Fund Balance—Governmental Funds

to the Statement of Activities For the year ended December 31, 2007 (amounts expressed in thousands)

Amounts reported for governmental activities in the statement of activities are different because:

Governmental funds report capital outlays as expenditures However, in the statement of activities the cost of those assets is allocated over their estimated useful lives and reported as depreciation expense This is the amount by which capital outlay exceeded depreciation expense in the current period:

Revenues in the statement of activities that do not provide current financial resources are not reported as revenue in the funds:

Change in revenues in fund statements previously recognized in Statement of Activities (5,932)

The issuance of long-term debt and other obligations (e.g., bonds, certificates of participation, and capital leases) provides current financial resources to governmental funds, while the repayment of the principal of long-term debt consumes the current financial resources of governmental funds Neither transaction, however has any effect on change in net assets

Also, governmental funds report the effect of issuance cost, premiums, discounts, and similar items when debt is first issued, whereas these amounts are deferred and amortized in the statement of activities These differences in the treatment of long-term debt and related items consist of:

Issuance costs, premium, discounts and deferred gain (loss) on refunding 4,425

Some expenses reported in the statement of activities do not require the use of current financial resources and, therefore, are not reported as expenditures in governmental funds:

Internal service funds are used by management to charge their cost to individual funds The net 3,644 expense of certain activities of internal service funds is reported within governmental

activities.