Solution manual advanced accounting 9e by hoyle ch16

Government-wide financial statements a statement of net assets and a statement of activities are designed to present an overview of the government as a whole and emphasizes operational

CHAPTER 16 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS,

PART I

Chapter Outline

I State and local government units produce two complete and distinct sets of financial

statements which are presented together in a comprehensive annual financial report

A User needs for governmental financial information are so diverse that the GASB

requires two sets of statements to be prepared The fund-based statements are more for the citizens whereas the government-wide statements are more for investors, such

as bondholders

B Fund-based financial statements are designed primarily to present information about the General Fund and other major activities This approach stresses fiscal accountability over financial resources

a For governmental funds, all current financial resources and claims to those financial resources are presented using modified accrual accounting for timing purposes

b For proprietary funds and fiduciary funds, all economic resources are reported using accrual accounting for timing purposes

C Government-wide financial statements (a statement of net assets and a statement of activities) are designed to present an overview of the government as a whole and

emphasizes operational accountability

a In these statements, all economic resources are measured using accrual accounting for timing purposes

b The governmental funds and most of the internal service funds are combined and reported as governmental activities

c The enterprise funds and any remaining internal service funds are combined and reported as business-type activities

d Because the government does not have control over the use of the assets reported

in the fiduciary funds, they are excluded from the government-wide financial

b Special revenue funds

c Capital projects funds

d Debt service funds

e Permanent funds

B Proprietary funds account for activities of the government where a user charge is

assessed

a Enterprise funds

b Internal service funds

C Fiduciary funds account for assets held in a trustee capacity for external parties

a Investment trust funds

b Private-purpose trust funds

c Pension trust funds

d Agency funds

III Governmental accounting has traditionally stressed establishing control over current

financial resources to ensure appropriate usage of the public’s money

A Budgetary entries are recorded for a number of the activities within the governmental funds

a The entry is recorded at the start of the year and is then reversed at the end of the year

b The initial and amended budget are reported along with actual figures for the period

as required supplemental information in the comprehensive annual financial report

As an alternative, this information can be shown as a separate statement within the fund-based financial statements

B Financial commitments (such as contracts and purchase orders) are recorded as

encumbrances

a These entries help avoid overspending of appropriated amounts

b The encumbrances are removed from the records when the commitment becomes a liability

IV In government-wide financial statements, acquiring a capital asset is reported as a capital asset and incurring an expense is reported as an expense However, for the governmental funds, on the fund-based financial statements, the reduction of current financial resources that results from the purchase of a capital asset, incurrence of an expense, or payment of a long-term debt is reported as an expenditure In this manner, the statements report the usage made of the money held by the government activity

A On the fund-based statements, supplies and prepaid items can be reported by either the consumption method or the purchases method

B On the government-wide financial statements, the recording of the acquisition of

infrastructure items such as bridges and sidewalks is required

V Governments often have nonexchange transactions where revenues such as taxes are received without a corresponding earning process To guide the recognition of such

transactions, four separate categories have been identified

A Derived tax revenues such as income taxes and sales taxes are recognized when the underlying event occurs

B Imposed nonexchange transactions such as property taxes, fines, and penalties are recognized when the resources are required to be used or in the first period when use is permitted

C Government-mandated nonexchange transactions, usually a government grant to fulfill a legally required objective, are recognized when all eligibility requirements have been met

D Voluntary nonexchange transactions such as most grants and gifts are recognized when all eligibility requirements have been met

VI Governments often raise significant amounts of financial resources by issuing long-term bonds

A In the government-wide financial statements, the debt is simply recorded

B In the fund-based financial statements for the governmental funds, the inflow of financial resources is reported as an ―other financing source.‖ Payment of the debt is shown as

an expenditure Long-term debts are not shown in the fund-based financial statements for the governmental funds

Learning Objectives

Having completed Chapter Sixteen of the textbook, ―Accounting for State and Local

Governments (Part One),‖ students should be able to fulfill each of the following learning

objectives:

1 Understand that two separate sets of financial statements must be created and reported by

a state or local government unit

2 Identify examples of the wide variety of users of government financial statements and

discuss their specific information needs

3 Explain the overall differences between government-wide financial statements and based financial statements

fund-4 Identify the three major classifications of funds and each of the individual fund types within those classifications

5 Describe the basic content of both government-wide financial statements and fund-based financial statements for the governmental funds

6 Explain the structure and reason for budgetary entries and the subsequent reporting of that information

7 Explain the structure and reason for recording encumbrances and the subsequent reporting

12 Describe the types of transfers that can occur within a government and indicate the

appropriate reporting for each type

Answer to Discussion Question

Is it an Asset or a Liability?

Some students seem to believe that the unique features of government financial reporting are more arbitrary than substantive To them, accounting is accounting and the specific type of reporting entity should not be an important consideration For that reason, this discussion question is placed early in the coverage of governmental accounting to point out that these entities do not necessarily view transactions in the same manner as a for-profit business Examination of the construction of a high school is an excellent example of the essential

accounting problems created by a government’s unique perspective The decision to build this

facility virtually assures the government that it will incur significant cash outflows for years to come Whereas a business constructs a building in hopes of generating cash inflows,

government officials are aware that the maintenance, heating, etc of the school will far

outweigh any direct cash inflows Hence, Mautz’s question – is it an asset or a liability—is not easy to answer Governmental accounting now solves this issue in a very unique way In the fund-based financial statements, construction costs are reported as an expenditure whereas, in the government-wide financial statements, the high school is reported as a capital asset The reduction in current financial resources is reflected in one statement but the cost of construction

is still shown as an asset in the other set of statements

Prior to class discussion, students can be required to read Mautz’s entire article as additional background information In class, students can be encouraged to discuss whether showing this high school in two such different ways is misleading or actually provides the information needed Students should be asked their opinion as to the benefit of having two completely different sets

of financial statements A quality, in-depth discussion can certainly result from the article

described here

Answers to Questions

1 User needs are often complex and contradictory Specific procedures in the governmental

reporting process are an outgrowth of those needs GASB Concepts Statement No.1,

―Objectives of Financial Reporting,‖ has identified three primary user groups: citizenry,

legislative and oversight bodies, and investors and creditors The needs of these users are broad and no single set of financial statements and principles can satisfy all expectations The satisfaction of diverse user needs is a constant focus of governmental accounting This has lead to the dual-perspective model which leads to the production of two distinct types of financial statements

2 Accountability and control have been a constant goal of governmental accounting

Governmental accounting provides the citizenry of a democracy with a method for

evaluating the governmental actions of raising and allocating resources Elected and

appointed officials have authority over the public’s money They should be held

accountable for generating and using these resources wisely in meeting the public’s needs Accounting shoud help citizens in evaluating these officials on their honesty, wisdom, and stewardship

3 GASB Statement No.34 has refined the reporting of governmental activities by providing

information about the government as a whole Focusing on individual accountability for the various government activities does not necessarily meet all user needs Government

reporting still focuses on current financial resources in the fund-based finacial statements, but provides an additional focus on all assets and all liabilities in the government-wide

financial statements, thus meeting broader user needs

4 Two financial statements make up the government-wide financial statements: The

Statement of Net Assets and The Statement of Activities There are a number of based financial statements The two fundamental financial statements covered here in Chapter 16 were the Balance Sheet for the governmental funds and the Statement of

fund-Revenues, Expenditures, and Other Changes in Fund Balances for the governmental funds.

5 In fund-based accounting, governmental funds use the current resources measurement focus and the modified accrual basis for the timing of revenue and expense recognition The current financial resources focus traditionally includes only assets such as cash,

receivables, and investments that can be used for spending purposes and the liabilities to

be paid out of these current assets The modified accrual basis recognizes revenues when they become available and measurable and expenditures when they cause a reduction in current financial resources Governments must disclose the length of time being used to determine availability

Proprietary and Fiduciary funds generally use the economic resources measurement focus and the accrual basis for the timing of revenue and expense recognition The economic resources measurement focus reports all assets (including capital and other noncurrent assets) as well as all liabilities (including long-term obligations)

6 Government-wide financial statements use the economic resources measurement focus and accrual accounting for the timing of revenue and expense recognition similar to for-profit organizations

7 Current financial resources are primarily cash, investments, and receivables These items are expected to be used to meet the current period government spending needs This category also normally includes inventories and prepaid expenses

8 Liabilities are recognized under the current financial resources focus when a claim against current financial resources is created In many cases, that means that payment will be made during the current period or within 60 days of the subsequent period Disclosure is required for the number of days being applied

9 Governmental Funds: Account for activities with a service orientation

a General Fund

b Special Revenue Fund

c Capital Projects Fund

d Debt Service Fund

e Permanent Fund

Proprietary Funds: Account for functions that are financed (at least in part) by user charges

a Enterprise Fund

b Internal Service Fund

Fiduciary Funds: Account for monies held by the government in a trustee capacity

a Investment Trust Fund

b Private-Purpose Trust Fund

c Pension Trust Fund

d Agency Fund

10 The following fund types fall within the governmental funds classification:

a The General Fund is used to account for ongoing activities such as public safety and sanitation More specifically, the General Fund records any activities that do not fall under one of the other fund types

b Special Revenue Funds account for financial resources that have been restricted as to expenditure for a specified operating purpose Money can come from sources such as grants, taxes, and gifts

c Capital Projects Funds account for monies (and their eventual expenditure) to be used

in acquiring or constructing government facilities or other capital assets

d Debt Service Funds account for the accumulation of resources that will be used to pay the principal and interest of long-term debts incurred by the service activities

e Permanent Funds account for assets contributed to the government by an external donor with the stipulation that the principal cannot be spent but any income can be used within the government, often for a designated purpose

11 The following fund types fall within the proprietary funds classification:

a An Enterprise Fund accounts for any governmental activity that is financed in whole or in part by outside user charges, such as a subway system

b An Internal Service Fund is used to record any activity that provides service to other departments or agencies within the government on a cost-reimbursement basis A motor pool, a centralized computer operation, or a print shop can be accounted for as Internal Service Funds if a user fee is charged and they only exist to serve the other functions of government

12 Fiduciary Funds: Account for monies held by the government in a trustee capacity

a Investment Trust Fund Accounts for the outside portion of investment pools where the reporting government has accepted funds from other governments resulting in a larger investment and hopefully a higher return

b Private-Purpose Trust Fund Accounts for money held in a trustee capacity, for

example, money confiscated from illegal operations

c Pension Trust Fund Accounts for the employee retirement system

d Agency Fund Accounts for resources held by the government as an agent for

individuals, private organizations, or other government units

13 In government-wide financial statements, financial figures are shown as either governmental activities or business-type activities All governmental funds and most internal service funds appear in the governmental acitivities All of the enterprise funds and any remaining internal service funds are lumped into the business-type activities Fiduciary funds are not shown in the government-wide financial statements

14 In fund-based financial statements, for the governmental funds, a separate column must be shown for (a) the General Fund, (b) any other fund that qualifies as major, and (c) all other funds accumulated as a whole in a single column

15 The physical recording of a budget is viewed as a method of expressing public policy and financial intent, providing a financial plan for the period The budget establishes spending limitations, which enhances financial planning and control The adoption of the budget for each activity anticipates the inflow of financing resources and sets approved expenditure levels Subsequently, comparisons can be drawn between actual and budgeted figures at any time during the fiscal period, thus evaluating performance

16 Comparisons between the original budget, the final budget, and actual figures must be reported in the required supplemental information presented after the notes to the financial

information in the comprehensive annual financial report Alternatively, the information can

be presented as a separate statement within the government’s fund-based financial

statements

17 An encumbrance is the recording of a purchase commitment (such as a contract or a

purchase order) The encumbrance entry is recorded at the time the commitment is made prior to incurring a liability This recording supports the spending control emphasis of the fund-based financial statements Reviewing the Expenditures account and the

Encumbrances balance provides the total amount of current financial resources spent and committed Thus, the chance of an over-commitment of resources is decreased The encumbrance is removed when this commitment becomes a legal liability Until then, no transaction has taken place so encumbrances are not included in government-wide financial statements

18 Encumbrances (commitments) that remain outstanding at the end of a fiscal period are reported within the Equity section as a reserved fund balance No liability is reported;

instead, the need to hold financial resources to satisfy the eventual cost of the commitment

is disclosed

19 Expenditures include outflows or reductions of net current financial resources from the acquisition of goods or services (or the payment of a long-term liability) Modified accrual accounting recognizes these expenditures when a claim against the current financial

resources is incurred that will be paid from resources that are available Fund-based

accounting for the governmental funds records expenditures instead of expenses and

capital assets

20 Modified accrual accounting recognizes expenditures when a claim against the current financial resources is incurred that will be paid from resources that are available

Governments must disclose the length of time (often 60 days) used to determine availability

21 Within the governmental funds, fund-based financial statements focus on expenditures rather than expenses Expenditures and transfers should be recorded when the liability is incurred Therefore, the entire cost of capital assets is treated as an expenditure as the liability is incurred

Government-wide financial statements record capital assets in a manner similar to for-profit organizations Buildings, machines, and other capital assets are capitalized and expensed over their useful lives

22 Traditionally, the purchase method has been used for prepaid expenses and supplies The cost is recorded immediately as an expenditure when the liability is incurred or the money is paid

Another method is the consumption method, which is similar to for-profit organization Supplies and prepayments are recorded as assets when acquired As they are then

consumed, they are recorded as expenditures matching them with the appropriate fiscal period

On fund-based financial statements for the governmental funds, either method can be selected

23 The four classifications of nonexchange revenues that a state or local government can recognize are:

a Derived tax revenues A tax assessment is imposed because an underlying exchange

takes place For example, revenues are recognized for a sales tax when a sale occurs and the tax is imposed

b Imposed nonexchange revenues An assessment is imposed but no underlying

transaction takes place Examples include property taxes and fines or penalties that are levied Revenues are recognized in the period when resources are required to be used or the first period that use is permitted

c Government-mandated nonexchange transactions Monies are provided from one

government to another to help pay for legally required programs or actions Examples include grants from the federal government to a city that must only be used for a

mandated legal requirement such as an improvement in the school system Revenues are recognized when all eligibility requirements have been met

d Voluntary nonexchange transactions Monies conveyed willingly to a state or local

government by an individual, another government, or an organization usually for a specific purpose but without legally mandated requirements Revenues are recognized when all eligibility requirements have been met An example would be money donated

to the city for the beautification of the local parks

24 A receivable is not recorded for property taxes until the demand for money represents an enforceable legal claim, which is normally specified by state law Many governments

encourage the early payment of property taxes (by sending out bills early or by giving some type of a cash discount) Thus, cash can actually be reported before the government even records the initial receivable

The revenue from the property tax should be reported net of estimated uncollectible tax in the period in which it is supposed to be used or the first period in which it can be used For example, property taxes assessed to finance the government's costs in 2008 should be reported as revenue in 2008

Because the receivable and the revenue recognition are split, it is possible to record the receivable (or cash, if collected early) before the revenue In that case, a Deferred Revenue account is established

25 No revenues are recognized in either set of financial statements because the proceeds of bonds must be paid back In fund-based financial statements, Cash is increased along with

an ―Other Financing Sources‖ figure For example, if the bonds were issued for a

construction project, this entry is recorded in the Capital Project Fund Payments of both interest and debt are then recorded when they become due, becoming a claim on current financial resources An Expenditure account is recognized for the debt and related interest and is usually shown in the Debt Service Fund

In government-wide financial statements, the cash and debt are both increased and

payment of debt would be similar to for-profit financial statements

26 A special assessment is an improvement made to property by the government, which is paid for in part or in whole by the owners of the property being benefited Adding curbing and sidewalks to a local street is an example of a special assessment if the residents of that street are required to pay a portion of the cost Typically, the government places a lien on the property to insure payment

The accounting for special assessment projects depends on the liability being incurred by the government If the government is in no way liable for the work done and any debt

incurred, an Agency Fund is used to account for the monetary inflows and outflows The government is simply serving as a conduit to get the project completed and the debt paid

If the government is responsible (even secondarily responsible) for the cost of the project, a more elaborate method of accounting is necessary In the government-wide financial

statements the debt and the infrastructure asset are recorded as in for-profit accounting The taxes are assessed, reported as revenues, collected, and used to pay the debt

The infrastructure asset and long-term debt are not recorded in the fund-based financial statements Instead, the expenditures for the work are recorded in a Capital Projects Fund while cash collected from citizens is recorded as revenue

27 In fund-based financial statements, interfund transactions are recorded in both funds

simultaneously at the time of authorization For example, monetary transfers from the General Fund to another fund such as the Debt Service Fund would be recorded in both funds

The recipient records this transfer as an ―Other Financing Source‖ and the party making the transfer records an ―Other Financing Use.‖

If the transfer is being made to a proprietary fund, it is often shown in the statement of revenues, expenses, and other changes in net assets as a ―capital contribution‖ or as a

―transfer in.‖

28 Intra-activity transactions occur totally within the governmental activities or totally within the business-type activities so that no net effect is created Therefore, these transfers are not reported on government-wide financial statements

Interactivity transactions occur between a governmental activity and a business-type activity

so that they affect the balances in each Consequently, they are reported in both columns

on the government-wide financial statements but are then offset in the total column

29 An internal exchange transaction is a transfer within the government that is recorded as if the transaction had actually occurred with an outside party Such transactions occur

between one of the government’s activities and an internal service or enterprise fund and are normally to pay for work or services being rendered These exchanges are reported as revenues and as either expenditures or expenses An example would be a payment from a police department to the city’s motor pool for vehicle maintenance This exchange would be included by both departments in the fund-based financial statements as if it were a

transaction with an outside party On government-wide financial statements, any such transactions between a government activity and a related internal service fund would be

considered an intra-activity transaction because both fund types are classified as

government activities and, therefore, there would be no impact on overall figures

Estimated Revenues Control 1,000,000

Estimated Other Financing Sources—Bond Proceeds 400,000

Appropriations Control 900,000 Appropriations-Other Financing Uses—Operating

Transfers Out 300,000 (Budgetary) Fund Balance 200,000

End of Year-Removal of budget

GENERAL FUND

Appropriations Control 900,000

Appropriations-Other Financing Uses—Operating

Transfers Out 300,000 (Budgetary) Fund Balance 200,000

Estimated Revenues Control 1,000,000

GOVERNMENT ACTIVITIES

In the end, the capital assets have gone up by the cost of the computer and

cash has been reduced by the same amount

FUND-BASED FINANCIAL STATEMENTS

GENERAL FUND

On the statement of revenues, expenditures, and other changes in fund

balance, an expenditure of $89,400 will be shown Cash will also decrease

by that amount

GOVERNMENT ACTIVITIES (Intra-activity transfer from the General Fund to the Capital Projects Fund is not reported)

On the statement of net assets, for the governmental activities, the

Buildings account goes up by $1,890,000, the Bonds Payable go up by $1.8 million, and cash goes down by $90,000

FUND-BASED FINANCIAL STATEMENTS

On the statement of revenues, expenditures, and other changes in fund

balance, the General Fund will report an other financing uses – transfer out

of $90,000 On its balance sheet, it will report $90,000 less cash For the capital projects fund, there will be an expenditure of $1,890,000 and two other financing sources: $90,000 as a transfer-in and $1.8 million from bond proceeds

a General Fund

Estimated Revenues Control

Estimated Other Financing Sources Control

(Budgetary) Fund Balance

Appropriations Control

b Capital Projects Fund (could also be recorded in the General Fund with

a transfer to the Capital Projects Fund)

Due to Capital Projects Fund (Special Assessment)

Capital Projects Fund

Due from General Fund

Other Financing Sources—Transfers In—General Fund

i The following entries are made on the assumption that the appropriate payment of the supplement is an eligibility requirement for the grant

Special Revenue Fund

g No entry (assuming the internal service fund is treated as a

governmental activity so that this is an intra-activity transaction)

h Governmental Activities

Property Taxes Receivable

Revenues—Property Taxes Allowance for Uncollectible Taxes

c Capital Projects Fund

g Special Revenue Fund

e Governmental Activities

f No entry – intra-activity transfer

a Capital Projects Fund (could also be recorded in the General Fund

followed by a transfer into the Capital Projects Fund)

b Capital Projects Fund (this entry depends on whether encumbrances are being recorded in the government’s Capital Projects Fund.)

GOVERNMENT-WIDE FINANCIAL STATEMENTS

35 a As the Appropriations account balance in the General Fund shows a

total of $171,000, that amount of money has been authorized for

expenditure during this fiscal period Thus, only that total can be

expended or committed To date, a total of $119,000 has been spent or committed ($110,000 of expenditures and $9,000 in encumbrances) The remaining $52,000 is still available

b The governmental funds are all designed to monitor current financial resources and their inflows and outflows Therefore, the Capital

Projects Fund records expenditures made in relation to the acquisition and construction of fixed assets Capital assets are recorded directly in government-wide financial statements

c The Appropriations balance represents the amount that government officials have authorized to be spent on a particular construction

project

d To alert readers to the commitment that remains outstanding, a year-end reclassification is made to reduce the ―Fund Balance—Unreserved, Undesignated‖ in order to report a ―Fund Balance-Reserved for

Encumbrances.‖

e The most likely explanation for the zero balance in the Fund Unreserved, Undesignated is that this capital project was begun during the current year, and thus, no closing entries have, as of yet, been

Balance-made In addition, many governments transfer in to the Capital Projects Fund the exact amount to be spent so that the inflows and outflows always agree and no fund balance is retained

f Two possible reasons can be put forth for the $150,000 Other Financing Sources balance First, a bond may have been sold Since the debt itself is not recorded in the fund-based financial statements, the

governmental fund must record the receipt by means of an Other

Financing Sources designation Second, the $150,000 may have come from a transfer (most likely from the General Fund) An operating

transfer is not considered revenue by the recipient and, therefore, the inflow of current financial resources is recorded as an Other Financing Source

g The Debt Service Fund is utilized to accumulate money to pay off the principal and interest of any long-term liability incurred by the

governmental funds The debt itself is maintained in the wide financial statements Payment of the debt and interest is made from the Debt Service Fund and those payments are recorded as

government-expenditures

h Special assessment projects are undertaken by a government to benefit particular properties with the owners bearing part (or all) of the cost Curbing, as an example, or the installation of lights usually are special assessment projects If the government has no responsibility for the costs, recording of all financial resources inflows and outflows is made

in an Agency Fund However, if the government does have some

responsibility (if, for example, the government is secondarily liable for any debts incurred), the construction is recorded in a Capital Projects Fund Thus, the receivable balance shown here would indicate that this project is being recorded in this manner Collection of the receivable will be made from the citizens being benefited; the money will be used

in paying for the construction

i This designation indicates that the government is reporting an asset that is not free to be spent for future expenditures In the asset section,

a $4,000 balance is being reported as the government’s Inventory of Supplies That figure is being reported but is not available to be spent

j Budgetary entries are optional for Debt Service Funds but are rarely used Expenditure levels (for principal and interest) are set

contractually by the debt indenture Thus, additional financial control is not obtained by the inclusion of budgetary amounts

Since estimated revenues exceed the appropriations, a surplus is

anticipated which is mirrored through a credit balance in the Budgetary Fund Balance account

b Initially, all of the school supplies are recorded in an asset account such as ―Inventory of Supplies.‖ As the supplies are used, the cost is reclassified into an Expenditures account On the balance sheet, a portion of the Fund Balance figure should be separated and reported as being reserved for Inventory of Supplies to show that this amount of assets is available to be spent

c When the balance sheet is produced, a Reserved Fund Balance amount will be reported to indicate that this amount of current financial

resources must be held to pay off the commitment for the truck when it eventually becomes an actual liability

d FUND-BASED FINANCIAL STATEMENTS

g EXPENDITURES:

Rent on equipment (assuming payments from

h FUND-BASED FINANCIAL STATEMENTS

Capital Projects Fund(or this could have been recorded in General Fund with the money then transferred to the Capital Projects Fund)

37 FUND-BASED FINANCIAL STATEMENTS

b Capital Projects Fund (encumbrances for these types of contracts are usually optional but are more likely to be made when budgetary entries are being used)

c Capital Projects Fund

d Capital Projects Fund

f Debt Service Fund

g General Fund

h Special Revenue Fund

h This entry is made in the Governmental Activities unless the toll road is reported as an Enterprise Fund in which case it is recorded as a

business-type activity