Solution manual advanced accounting 9e by hoyle ch17

For governmental accounting, a primary government such as a city or town is a reporting entity that normally produces a comprehensive annual financial report CAFR.. The primary governmen

CHAPTER 17 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS,

PART II

Chapter Outline

I Government entities sometimes obtain property by lease rather than by purchase

A Leases are recorded as either capital leases or operating leases based upon the

criteria first established by FASB Statement 13

B Based on this standard, a lease that meets any one of the following criteria is a capital lease:

a The lease transfers ownership of the property to the lessee by the end of the lease term

b The lease contains an option to purchase the leased property at a bargain price

c The lease term is equal to or greater than 75 percent of the economic life

of the leased property

d The present value of minimum lease payments equals or exceeds 90 percent of the fair value of the leased property

C For a state or local government, a capital lease is recorded as follows:

a In the government-wide financial statements, the lease is reported as an asset and liability at the present value of the minimum leases payments and then

depreciation (on the asset) and interest (on the liability) are recognized in the same manner as used by for-profit organizations

b In the fund-based financial statements for government funds, the present value of the minimum lease payments is recorded as an expenditure and an other financing source with later interest and principal payments recorded as expenditures No depreciation is recognized because the asset is not recognized

II Governments often establish solid waste landfills They can be recorded within the

proprietary funds, if a user fee is assessed, or as part of the general fund if the landfill is open to the public without a charge

A A landfill can eventually create a large liability for the government because of closure costs and post-closure maintenance and monitoring

B On government-wide financial statements, recognition of this liability is based on accrual accounting and the economic resource measurement focus Thus, the liability is

recognized as the available space becomes filled If the landfill is recorded as an

Enterprise Fund, this same reporting is appropriate for fund-based financial statements

C If the landfill is reported within the General Fund, the liability is only reported on the fund-based statements when there is a claim to current financial resources

III Governments incur a liability for compensated absences earned by government employees such as school teachers and police officers

A Government-wide financial statements require recognition of the liability and expense

as incurred based on accrual accounting and the economic resource measurement focus

B Fund-based financial statements record a liability only if the claim is to be paid from current financial resources

IV Works of Art and Historical Treasures

A Artworks, historical treasures, and similar assets should be capitalized at cost (or fair value at the date of donation) in government-wide financial statements

B An expense rather than an asset can be recorded if the item does not generate

economic benefits and meets the following criteria

a Held for public exhibition, education, or research in furtherance of public service, rather than financial gain

b Protected, kept unencumbered, cared for, and preserved

c Subject to the policy that revenues generated from sales of items in the collection

be used to add to the collection

C If capitalized, depreciation is not required if this type of asset is considered to be

inexhaustible

V Infrastructure Assets and Depreciation

A Newly-acquired infrastructure assets (such as roads, bridges, and sidewalks) should be capitalized at historical cost in the government-wide financial statements and recorded

as an expenditure in the fund-based financial statements

B Major general infrastructure assets put into service since 1980 must also be capitalized although an estimation of current book value may be necessary

C Depreciation of all capital assets other than land and inexhaustible artworks is required

so that infrastructure items are also subject to depreciation

D However, the “modified approach” allows the expensing of maintenance costs in lieu of depreciation for infrastructure assets if certain criteria are met

a A minimum acceptable condition level is established for a network of infrastructure assets and documentation is provided to show that this minimum level has been maintained

b An asset management system must be in place to monitor the particular system of assets

VI The comprehensive annual financial report (CAFR) includes general purpose external financial statements These statements are divided into three distinct sections

A Management’s discussion and analysis (MD&A) which provides a broad range of information to help decision-makers evaluate the operations and financial position of the government entities

B Financial statements

a Government-wide financial statements

b Fund-based financial statements

c Notes to the financial statements

C Required supplementary information

VII For governmental accounting, a primary government such as a city or town is a reporting entity that normally produces a comprehensive annual financial report (CAFR)

A In addition, a special purpose government (such as a school board or water

commission) qualifies as a reporting entity if it meets the following three criteria:

a It has a separately elected governing body

b It is legally independent

c It is fiscally independent of any other state and local governments

B Component units that meet either of the following two criteria should be reported within the CAFR of the reporting government even though they are independent operations

a It must be fiscally dependent upon the primary organization or

b The primary government must appoint a voting majority of the governing board and either be able to impose its will on the component organization or the component organization provides a financial benefit or imposes a financial burden on the

primary government

C Once identified, component units can be discretely presented in a separate column to the right of the government-wide statements or blended with the primary government as

if it made up a part of the primary organization

VIII Public colleges are required to meet GASB standards, whereas private colleges are

required to meet FASB standards

A Private colleges generally depend more on tuition and usually have greater

endowments

B Governments provide the major support for public colleges

C GASB No 35 requires the application of GASB No 34 to public colleges However,

many of these schools assume that they function solely as an Enterprise Fund (open to the public for a user charge) Thus, these schools are allowed to produce fund-based financial statements without need for government-wide statements

Learning Objectives

Having completed Chapter Seventeen of the textbook, “Accounting for State and Local

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

3 Understand how a landfill can generate a large liability for a government and the difference

in the recognition and the subsequent recording of this liability in the government-wide financial statements and the fund-based financial statements

4 Understand how governments incur a liability for compensated absences earned by

government employees and the difference in their subsequent recording in the wide financial statements and the fund-based financial statements

government-5 Explain the capitalization rules for art, historical treasures, and similar assets and their subsequent recording in the government-wide and in the fund-based financial statements

6 Describe when an exception to the required capitalization and depreciation rules for art, historical treasures, or similar assets is justified

7 Understand the accounting that is required for a government’s infrastructure assets such as bridges and sidwalks

8 Explain the criteria for the “modified approach” that allows expensing of maintenance costs

in lieu of depreciation for infrastructure assets

9 Describe the three distinct sections of the general purpose external financial statements

10 Be able to explain when an operation (such as a school system) that is not a primary

government (such as a city or state) is still viewed as a reporting entity for government accounting purposes

11 Explain the criteria that must be met to be reported as a component unit and the difference

in reporting between a unit that is discretely presented and one that is shown as a blended unit

12 Describe the two government-wide financial statements

13 Describe the traditional fund-based financial statements, especially for the governmental funds and for the proprietary funds

14 Explain the method by which governmental accounting rules are applied to public colleges and universities

Answer to Discussion Question

Is It Part of the County?

In financial accounting for a for-profit organization, the boundary for the reporting entity and its various activities (or subsidiaries) is relatively easy to determine GAAP provides the basis for inclusion in the consolidated financial statements, which includes all entities over which a

company has control

In accounting for state and local governments, the distinction is not so clear What constitutes a reporting entity? Obviously, a primary government such as a city or county is a reporting entity What about other governmental operations and activities that exist separate from a primary government? When do those operations qualify as special purpose governments and when should they be viewed as component units to be reported by a primary government?

A special purpose government is a reporting entity It has a separately elected governing body,

it is legally independent, and it is fiscally independent Fiscal independence constitutes setting its own budget, levying taxes, and/or issuing bonds without outside approval Here, the

industrial development commission is not fiscally independent of Harland County Harland County has the ability to impose its will on the separate organization by its right to approve the commission’s budget Therefore, the industrial development commission is not a special

purpose government

Is the industrial development commission a component unit? Component units are not always easy to determine An activity is classified as a component unit if it is fiscally dependent on the primary government Because the commission’s budget must be approved by the county

government, the commission would appear to qualify as a component unit for Harland County

Can the commission also be a component unit of the state? There is not fiscal dependence but

a component unit does exist if the primary government appoints a voting majority of the board and (a) the primary government can impose its will on that board or (b) the separate

organization provides a financial benefit for the primary government or imposes a financial burden The state does appoint 15 out of 20 of the board members appointment of that

number of board members does indicate state control However, there is no evidence or

information here that indicates that the state can impose its will on the board or that the

separate organization provides a financial benefit or imposes a financial burden on the state Therefore, unless other information becomes available indicating that one these requirements is present, the industrial commission is not a component unit of the state However, because of the appointment of the majority of the board, the commission is a related organization to the state In that case, the state must disclose the nature of the relationship in its financial

statements

Answers to Questions

1 State and local governments apply FASB Statement Number 13, “Accounting for Leases,”

to determine whether a lease is a capital lease or an operating lease A lease that meets any one of the following criteria is held to be a capital lease:

a The lease transfers ownership of the property to the lessee by the end of the lease term

b The lease contains an option to purchase the leased property at a bargain price

c The lease term is equal to or greater than 75 percent of the estimated economic life of the leased property

d The present value of rental or other minimum lease payments equals or exceeds 90 percent of the fair value of the leased property

2 Within the government-wide financial statements, the accounting for capitalized leases is the same as for-profit enterprises The asset and liability are initially recorded at the present value of the minimum lease payments Accrual accounting and the economic resource measurement basis are appropriately followed The equipment would be increased along with the liability obligation Subsequently, both depreciation expense and interest expense must be recognized The entries in the fund-based financial statements are the same if a proprietary fund is involved

The recording of a capital lease in one of the governmental funds within the fund-based statements involves the following three steps:

a The initial entry reports the present value of the liability as an other financing

of the lease obligation

In fund-based financial statements, the recording is the same if a proprietary fund is

involved However, the recording of a capital lease payment in the governmental funds involves the recording of the debt and interest payments as expenditures

4 Solid waste landfills can be a significant source of liability for local governments The federal government has strict rules on groundwater monitoring and post-closure activities This legal obligations can involve large payments over an extended period of time even after the landfill is closed

5 Government-wide financial statements recognize expenses on the accrual and economic resource measurement basis Therefore, seven percent of the expected landfill closure liability cost would be accrued during the current year as an expense and to report the proper liability

In the fund-based financial statements, the entry is the same as above if an Enterprise Fund

is involved

In the fund-based statements, if the landfill is recorded in the General Fund, the only charge

to expenditures is a current payment, if it is made Thus, the eventual liability is ignored unless it will be paid from current financial resources

6 Government-wide financial statements recognize expenses on the accrual and economic resource measurement basis At the end of the first year, 11 percent is multiplied times the expected closing and other related costs and that figure is recognized as both an expense and a liability At the end of the second year, 24 percent is multiplied times the expected costs (which may have changed since the end of year one) and the liability to be reported is raised to this new amount It is the change in the liability that creates the amount of

expense to be reported for the second year

For fund-based financial statements, assuming the landfill is reported in the General Fund,

no recording is made unless (a) an actual payment is made because of the eventual closure

or (b) some part of that liability represents a claim to current financial resources in this

period

7 The amount accrued, $2,000 in this case, should be recorded on the government-wide financial statements as an expense at the end of 2008 along with the related liability As a governmental fund transaction, the fund-based financial statements only include an amount

as a liability at the end of 2008 if it is to be paid early enough in 2009 to require the use of current financial resources held at the end of 2008 (which does not appear to be the case)

8 Because of the accrual recorded on the government-wide financial statements at the end of

2008, the actual payment simply reduces both cash and the liability balance

On the fund-based financial statements, assuming no accrual was reported in 2008, the payment in 2009 is a reduction in cash along with an Expenditure balance If the amount is paid with proprietary funds, it is treated the same as in government-wide statements

9 Governments should capitalize donated works of art, historical treasures, and similar assets

at the fair value at the date of the gift However, if there is no charge for admission to see the art, it is difficult to consider it an asset because it generates no economic benefit Thus, the artwork does not have to be capitalized if all of the following criteria are met:

a Held for public exhibition, education, or research in furtherance of public service, rather than financial gain

b Protected, kept unencumbered, cared for, and preserved

c Subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections

If capitalized, depreciation is only required if the asset is exhaustible This means that the asset is used up by display, education, or research Otherwise, depreciation is not required

10 A revenue still must be reported because of the donation If the government chooses not to record the qualifying asset in the government-wide financial statements, an expense must

be reported in place of the asset whether purchased or received as a gift If the item is received by donation, the revenue portion of the entry is required

11 The modified approach is an alternative to depreciating infrastructure assets This approach allows the government to expense all maintenance costs rather than record depreciation but only if certain guidelines are met The government must accumulate certain information about particular infrastructure assets within either a network or subsystem of a network The government must establish a minimum acceptable level for the network or subsystem of the network and maintain documentation that this level is being maintained An asset

management system must be in place to monitor and provide records of the infrastructure assets.The ongoing condition must be assessed and an annual estimation made of the cost

of maintaining and preserving the infrastructure to meet the established condition levels Governments must determine whether this amount of work should be carried out simply to avoid the recording of depreciation

12 Depreciation of infrastructure assets is not recorded but all maintenance is expensed Also,

in applying the modified approach, certain disclosures are required on the government-wide financial statements This includes disclosure that the government is accumulating certain information about particular infrastructure assets within either a network or subsystem of a network The disclosure must include specific information about the minimum acceptable level for the network or subsystem of the network and that this level is being maintained and monitored by an asset management system

13 A Management’s Discussion and Analysis (MD&A) similar to profit-making financial

statements is now required for state and local governments.The MD&A is presented before the financial statements and provides the following information:

(1) A brief discussion of the financial statements and information provided and their

relationships to each other

(2) Condensed financial information at least including

a Total capital and other assets

b Total long-term and other liabilities

c Total net assets, including amounts invested, in capital assets net of debt, restricted and unrestricted amounts

d Program revenues, by major source

e General revenues, by major source

f Total revenues

g Program expenses, by function

h Total expenses

i Excess or deficiency before contributions to term and permanent fund principal, special and extraordinary items, and transfers

j Contributions

k Special and extraordinary items

l Transfers

m Change in net assets

n Ending net assets

(3) Overall financial position and results of operations

(4) Balances and transactions analyses with explanation of significant changes

(5) Analysis of significant variations between original and final budget amounts

(6) Description of significant capital asset and long-term debt activity

(7) Information about the modified approach for infrastructure assets

(8) Any known facts, decisions, or conditions that are expected to significantly impact on financial position or results of operations

14 The Comprehensive Annual Financial Report (CAFR) includes three sections

1 MD&A (Management’s Discussion & Analysis)

2 General purpose financial statements

3 Auditor’s report

4 Other required supplementary information

c Statistical Section

15 A general purpose government is a traditional government such as a city, county, or state

A special purpose government (such as school system) can also be a primary government for reporting purposes if certain requirements are met

Classification as a special purpose government requires meeting three criteria:

a It has a separately elected governing body

b It is legally independent It can sue and be sued and buy, sell, and lease property

c It is fiscally independent of other state and local governments It can determine its own budget, levy and set tax rates, and issue bonded debt without outside approval

16 Classification as a component unit requires meeting one of two criteria:

a The activity is fiscally dependent on a state or local government It cannot determine its own budget, levy and set tax rates, and issue bonded debt without outside approval

or

b An outside primary government appoints a voting majority of the governing board of the activity The primary organization must also be able to do one or more of the following: impose its will on the board of the component organization, or provide a financial benefit

to the component organization, or the component organization provides a financial benefit to the primary government

17 If blended, component units are included in the primary government as if they were part of the government The component unit is legally separate but so intertwined and substantially the same as the primary government so that inclusion is necessary for appropriate

presentation

A discretely presented component unit is shown separately on the far right side of the

government-wide financial statements because the organization is not substantially the same as the government and can stand alone

18 The two government-wide financial statements are the Statement of Net Assets and the Statement of Activities

The Statement of Net Assets includes:

a All assets and long-term liabilities

b Capital assets net of accumulated depreciation including newly acquired infrastructure assets

c The primary government is divided into governmental or business-type activities

d The internal balances reflect inter-activity transactions between governmental and business-type activities

e Discretely presented component units are shown to the far right of the statement

The Statement of Activities includes:

a Expenses by function

b Interest expense on long-term debt

c Related program revenues including charges for services, operating grants and

contributions, and capital grants and contributions

d Net expenses and revenues for each function

e Net expenses and revenues for each category of the government

f General revenues for governmental activities, business-type revenues, or component units

g Special items that are significant transactions or other events within the control of

management that are either unusual or infrequent in nature

h Transfers between governmental and business-type activities

19 The two fund-based financial statements for government funds are the Balance Sheet and the Statement of Revenues, Expenditures, and Changes in Fund Balance The Balance Sheet measures current financial resources and uses modified accrual accounting and includes:

a Separate columns for the general fund and other major funds

b Non-major funds are combined and reported as “other governmental funds.”

c Totals for government funds

d Fund Balance Reserved shows financial resources encumbered or reserved for other purposes

The Statement of Revenues, Expenditures, and Changes in Fund Balance includes:

a The general fund and each major fund in separate columns, with all minor funds in another column

b Revenues

c Expenditures

d Other financing sources and uses

General revenues are those from the population as a whole including property taxes, sales taxes, unrestricted grants, and investment income They are not traced to any individual program

This distinction is important because program revenues are matched with expenses for each activity providing a net expense or revenue figure for each

21 The net expenses and revenues format allows the users of a government’s financial

statements to determine the relative financial burden (or benefit) that each of its reporting functions has on its taxpayers In other words, the users of the statement can determine what it costs for the government to provide benefits such as public safety

22 On government-wide financial statements, internal service funds are combined with the governmental activities (or business-type activities if more appropriate) Their placement is based on the identity of the functions that they primarily serve If an internal service fund is mainly used to serve one or more governmental funds, then it should be included with the governmental activities

23 Fiduciary funds are not reported on government-wide financial statements because these resources must be used for a purpose outside of the primary government

24 From a reporting perspective, the FASB sets accounting standards for private colleges while the GASB sets standards for public universities Operationally, public universities receive signficant funding from a government (usually a state government), whereas private

universities rely more on tuition charges Because of the ability to generate funding from the government, public colleges generally have smaller endowments

25 Many public colleges and universities make the assumption that they are solely an

Enterprise Fund because they are open to the public but have a user charge (tuition and other fees) For proprietary funds, government-wide financial statements and fund-based financial statements are quite similar Consequently, the authoritative guidelines allow such schools to produce only fund-based financial statements and avoid the redundancy of also creating government-wide statements

Answers to Problems

2 D ($49,000 expenditure on the first day of the capital lease and then

$70,000 more in the form of payments made over the life of the lease)

activity) and the fund-based financial statements (as a Proprietary Fund)

December 31, 2009 (obligation is now $49,064 or $65,800 less $16,736)

FUND-BASED FINANCIAL STATEMENTS

Proprietary Fund (should be same as handling in government-wide

statements)

January 1, 2008

GOVERNMENT-WIDE FINANCIAL STATEMENTS

Accounted for as an Enterprise Fund (within the Business-type Activities)

December 31, 2008

Expense—Landfill Closure (3% of $1.9 million) 57,000

December 31, 2009

Expense—Landfill Closure

b

Accounted for as a General Fund (within the Governmental Activities)

December 31, 2008

December 31, 2009

c

FUND-BASED FINANCIAL STATEMENTS (same as above)

Accounted for as an Enterprise Fund (within the Proprietary Funds)

December 31, 2008

December 31, 2009

d

FUND-BASED FINANCIAL STATEMENTS

Accounted for as a General Fund (within the Governmental Funds)

31 a GOVERNMENT-WIDE FINANCIAL STATEMENTS

December 31, 2008

b FUND-BASED FINANCIAL STATEMENTS

December 31, 2008

Despite the huge eventual liability, there is nothing recognized at the end

of 2008 because there is not a claim to any current financial resources

32 a GOVERNMENT-WIDE FINANCIAL STATEMENTS

b FUND-BASED FINANCIAL STATEMENTS

December 31, 2008 —This vacation is taken early enough in the following

year to necessitate the use of current financial resources

c December 31, 2008 —It is assumed that this vacation is taken late enough

in the following year so as not to affect current financial resources

Therefore, there is no entry in 2008 There is not a claim that will require current financial resources

Late in 2009

33 a GOVERNMENT—WIDE FINANCIAL STATEMENTS

35 GOVERNMENT-WIDE FINANCIAL STATEMENTS

One possibility: Infrastructure assets with depreciation recorded

Subsequent Entries

Accumulated Depreciation

Second possibility: Infrastructure assets using the modified approach

36 a The major criterion for inclusion in a government’s comprehensive annual

financial report is financial accountability

b An activity is viewed as a special purpose government if it meets the

following criteria:

1 Has a separately elected governing board

2 Is legally separate

3 Is fiscally independent of other governments

c Legal separation is usually demonstrated by having corporate powers such

as the right to buy and sell property as well as the right to sue and be sued Corporate powers depends on state law so that determination of legal

separation may differ from one state to another

d The fiscal independence of a government is indicated by having authority

component unit are included along with the financial statements of the

primary government However, these reported figures must be discretely presented separate from the balances of the primary government The financial information for the components is usually reported to the right of the primary government All component units may be shown individually, combined into a single column, or combined into separate columns for governmental and proprietary operations As indicated in (g) below,

blending is also a possible way of reporting a component unit

f One of the criteria for identifying a component unit includes the primary government’s ability to impose its will on the component unit A primary government is assumed to have this ability if it can (1) remove an

appointed board member at will, (2) modify or approve budgets, (3)

override decisions of the board, or (4) hire as well as dismiss the

individuals in charge of the day-to-day activities of the component unit

g Normally, as indicated above, the financial position and operations of a component unit are shown separately from the primary government

However, if the component unit is sufficiently intertwined with the primary government it is included within the government figures This inclusion is referred to as blending

h A primary government may appoint a voting majority of an activity’s board but have no financial accountability In such cases, the activity is neither a part of the primary government nor a component unit However, because

a majority of the board is appointed by the primary government, the activity

is considered a related organization Consequently, the identity of the

activity and its relationship must be spelled out in the notes to the financial statements of the primary government

38 a CITY OF WILLIAMSON

STATEMENT OF ACTIVITIES For Year Ended December 31, 2008

Net (Expense) Revenue and Program Revenues Changes in Net Assets

Charges for Grants and Grants and Governmental Business-type Functions/Programs Expenses Services Contributions Contributions Activities Activities Total Governmental activities

38 a (continued)

Computations:

General Governmental [$66,000 + 11,000 + 21,000 + 8,000 + 4,000 (salaries

payable) + 13,000 (compensated absences) + 14,000 (art work) + 12,000

(depreciation on building: $120,000/10 years)] = $149,000

Public Safety [$39,000 + 18,000 + 5,000 + 9,000 (expired insurance) + 12,000 (supplies used) + 7,000 (salaries payable)] = $90,000

Health and Sanitation [$22,000 + 3,000 + 9,000 + 12,000 + 8,000 (salaries

payable) + 16,000 (depreciation on equipment: $80,000/5 years)] = $70,000

38 a (continued)

CITY OF WILLIAMSON STATEMENT OF NET ASSETS December 31, 2008

Invested in capital assets,

38 (continued)

b

CITY OF WILLIAMSON STATEMENT OF REVENUES, EXPENDITURES, AND CHANGES IN FUND

BALANCES Governmental Funds For Year Ended December 31, 2008

Other Financing Sources:

Fund Balances (Beginning) -0- -0-

38 b (continued)

CITY OF WILLIAMSON BALANCE SHEET Governmental Funds December 31, 2008

39 a CITY OF BERNARD

STATEMENT OF ACTIVITIES For Year Ended December 31, 2008

Net (Expense) Revenue and Program Revenues Changes in Net Assets

Charges for Grants and Governmental

Change During 2008 $ 282,500 $ 282,500

39 a (continued)

CITY OF BERNARD STATEMENT OF NET ASSETS December 31, 2008

Net assets

Invested in capital assets,