solution manual advanced financial accounting 8th edition baker chap017

CHAPTER 17 GOVERNMENTAL ENTITIES: INTRODUCTION AND GENERAL FUND ACCOUNTING ANSWERS TO QUESTIONS Q17-1 A fund is an independent fiscal and accounting entity with a self-balancing set o

CHAPTER 17

GOVERNMENTAL ENTITIES: INTRODUCTION AND GENERAL FUND

ACCOUNTING

ANSWERS TO QUESTIONS

Q17-1 A fund is an independent fiscal and accounting entity with a self-balancing set of

accounts recording cash and/or other resources together with all related liabilities, obligations, reserves, and equities which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations A fund may receive resources from a variety of sources, including collection of taxes on property, income, or commercial sales; receipt of grants, fines, or licenses; and collection of service charges

Q17-2 The eleven funds generally used by local and state governments are:

Governmental

a General fund

b Special revenue fund

c Capital projects fund

d Debt service fund

e Permanent fund Proprietary

f Internal service fund

g Enterprise fund Fiduciary

h Pension trust fund

i Investment trust fund

j Private-purpose trust fund

k Agency funds The purpose of each fund is individually discussed below:

a General fund: All financial resources except those required to be accounted for in

another fund are accounted for in the general fund

b Special revenue fund: The proceeds of specific revenue sources that are legally

restricted for specified purposes are accounted for in the special revenue fund

c Capital projects fund: Financial resources to be used for the acquisition or

construction of major capital projects that will benefit a large population are accounted for in the capital projects fund

Q17-2 (continued)

d Debt service fund: The accumulation of resources for and the payment of, general

long-term debt principal and interest are accounted for in the debt service fund

e Permanent fund: Accounts for resources for which the principal must be maintained,

but for which the earnings may be used in support of governmental programs

f Internal service fund: The financing of goods or services provided by one department

or agency to other departments or agencies of the governmental unit, or to other governmental units, are accounted for in internal service funds

g Enterprise fund: Operations of governmental units that charge for services provided

to the general public are accounted for in the enterprise funds

h Pension trust fund: Resources held by a governmental unit in a trustee capacity for

the members and beneficiaries of pension plans, postemployment plans, or other employee benefit plans

i Investment trust funds: Accounts for the external portion of investment pools of

governing units

j Private-purpose trust fund: Accounts for trust arrangements under which both

principal and interest may be used to benefit specific individuals, private organizations,

or other governmental units Note that these resources have specific purposes as stated by the donor or grantor, and are not available for general governmental programs

k Agency funds: Assets held by a governmental unit in an agency capacity for

employees or other individuals are accounted for in agency funds

Q17-3 The modified accrual basis includes some aspects of accrual accounting and some

aspects of cash-basis accounting Under the modified accrual basis, the emphasis is on reporting how well the government performed by focusing on when the revenue and expenditures are recognized in the accounts and reported in the financial statements The emphasis is not on how much was earned or on the amount of expenses

Q17-4 The modified accrual basis is used for funds for which expendability is the concern

because the governing entity is interested in the determination of the resources still remaining to be expended to carry out the objectives of the fund

Q17-5 Property taxes are recognized as revenue in the general fund when the taxes are

levied, provided they apply to and are collectible within the current fiscal period, or within a short period (< 60 days) after the end of the fiscal period

Q17-6 GASB 33 states that taxpayer-assessed income and sales taxes should be accrued in

the general fund when they become both measurable and available to finance expenditures of the fiscal period Sales taxes held by other governmental units should be recognized if the taxes are both measurable and available for expenditure Measurability in this case is based

on an estimate of the sales taxes to be received, and availability is based on the ability of the governing entity that will receive the future distribution to obtain current resources through credit by using future sales tax receipts as collateral for the loan

Q17-7 Budgetary accounting is the entering of the budgeted revenue, appropriations, and

net increase or decrease in fund balance into the formal accounting records as a formal accounting control mechanism Expected revenue is accounted for as estimated revenue, an anticipatory asset account The governmental unit anticipates receiving resources from the revenue sources listed in the budget Anticipated expenditures are accounted for as appropriations, an anticipatory liability account The governmental unit anticipates incurring liabilities for the budgeted amount Both the expected revenue and the appropriations accounts are closed at the end of the fiscal period

Q17-8 All expenditures are not encumbered Payroll costs and other costs for goods

received from within the governmental entity are not encumbered because these are normal and recurring costs

Q17-9 Some governmental units do not report small amounts of inventories of supplies in

their balance sheets because the amount of inventory is not material

Q17-10 Under the lapsing method the Reserve for Encumbrances account is shown as a

reservation of the fund balance on the fiscal year-end balance sheet The encumbrance account is a nominal account that is closed at the end of the fiscal period The net effect is to close out the remaining encumbrances against the fund balance-unreserved Alternatively, the GASB does allow for just footnote disclosure of the lapsing open orders at year-end that are expected to be honored in the next fiscal period

Under the nonlapsing method the expenditure authority from prior periods is carried over as nonlapsing encumbrances The budget for the next fiscal period does not include these carryovers and is more realistic for situations in which orders placed with outside vendors cannot easily be canceled The encumbrances account and the budgetary reserve for encumbrances account are still closed at the end of the first period

When accounting for the actual expenditure in the subsequent year, the lapsing method requires the new governing board to decide if it will honor the outstanding encumbrances f rom the previous year by including them in the current budgeted appropriations If the governing board accepts the obligation to honor their outstanding purchase orders from the prior year, the recording of the current year’s budget establishes the expenditure authority for the prior year-end’s open encumbrance In the event the new governing board decides not to honor the outstanding encumbrances, the reserve for outstanding encumbrances is closed to the unreserved fund balance and the order for the goods is cancelled with the external vendor When accounting for the actual expenditure in the subsequent year, the nonlapsing method separates expenditures made from spending authority carried over from prior periods This is done in a reclassification entry made on the first day of the next fiscal period, which dates the reserve for encumbrances When the goods are received in the second year, the

Q17-11 The expenditure for inventories is recognized in the period the supplies are

acquired under the purchase method Under the consumption method, the expenditure for inventories is recognized for only the amount of inventory used in the period

Q17-12 Interfund services provided and used are interfund activities that would be treated

as revenues or expenditures if they were made with parties external to the governmental entity An example would be if the general fund purchased supplies from the internal service

Interfund transfers out or in are transfers of resources between funds An example would

be a transfer of resources from the general fund (an interfund transfer out) to the capital projects fund (a transfer in) to assist in the construction costs of a new municipal building

Q17-13 An interfund transfer is reported as "Other Financing Sources or Uses" in the

general fund's statement of revenues, expenditures, and changes in fund balance

Q17-14 The loan of $2,000 from the general fund to the enterprise fund is reported on the

financial statements of the general fund on the balance sheet as a receivable The loan is not shown on the fund's statement of revenues, expenditures, and changes in fund balance

Q17-15 Governmental accounting places many controls over expenditures, and much of

the financial reporting focuses on the various aspects of an expenditure An expenditure can be made for a function of the governmental entity or an activity within a function Expenditures for an activity can be classified by object, which is the type of expenditure The extensive detail required to account for and cross reference an expenditure to ensure it

is properly classified at all levels requires a very comprehensive accounting system

SOLUTIONS TO CASES

C17-1 Budget Theory

a A governmental accounting system must make it possible to:

1 Present fairly and with full disclosure, in conformity with generally accepted accounting principles, the financial position and results of financial operations of the funds and account groups of the governmental unit

2 Determine and demonstrate compliance with finance-related legal and contractual provisions

Because the legislative body enacts the budget into law, the budget is recorded in the accounts of a governmental unit This enables a governmental unit to show legal compliance with the budget by providing an accounting system that measures actual expenditures and obligations against amounts appropriated and actual revenue against estimated revenue Appropriations enacted into law constitute maximum expenditure authorizations during the fiscal year, and they cannot legally be exceeded unless subsequently amended by the legislative body

b As the new fiscal year begins, the budget, already enacted in law by the legislative body, is recorded Budgetary accounts are set up to record the estimated revenue and appropriations in the fund accounts by debiting estimated revenue and crediting appropriations If there is a difference between estimated revenue and appropriations, the excess or deficit is credited or debited, respectively, to fund balance In addition, subsidiary ledger accounts are maintained for estimated revenue by source and for appropriation/expenditure items

At the end of the fiscal year, the estimated revenue and the appropriations accounts are among other budgetary accounts closed out to the budgetary fund balance

C17-2 Municipal versus Financial Accounting

a The most significant difference in purpose between municipal accounting and commercial accounting is that commercial enterprises are operated for profit, which places much emphasis on the proper determination of periodic earnings Governmental units are primarily concerned with providing services to their citizens at minimum cost and reporting

on the stewardship of public officials with respect to public funds, which places much emphasis on budgetary controls However, some municipal units perform commercial services that are generally secondary to their tax-financed primary services

Another difference in accounting purpose is that municipal accounting operations are controlled by legal provisions in constitutions, charters, and regulations having the force and effect of law Because of these legal provisions and the diversity of its governmental operations, a municipality cannot use a single, unified set of accounts for recording and summarizing all financial transactions If there is a conflict between legal provisions and generally accepted accounting principles applicable to governmental units, legal provisions should take precedence to the extent that the accounting system must enable the ready disclosure of compliance However, for financial reporting purposes, generally accepted accounting principles must take precedence Commercial enterprises usually are not controlled by charters that are restrictive; therefore, their accounting systems are designed differently

Legislative action may limit the use of certain tax revenue for expenditure on particular programs, the methods of tax collection, or the rates of tax assessment Such provisions must be reflected in the accounting system and be appropriately disclosed in the municipality's financial statements as a report on the stewardship of public officials with respect to public funds

In governmental accounting all required accounts are organized on the basis of funds, each

of which is independent of the other Each fund must be so accounted for that the identity

of its resources, obligations, revenue, expenditures, and fund balance is continually maintained These purposes are accomplished by providing a complete self-balancing set

of accounts for each fund

The basis of accounting for the reporting on governmental units is often different from that used by commercial enterprises For example, the accrual basis of accounting is recommended for all funds except the governmental funds The governmental funds should

be accounted for by the modified accrual basis The modified accrual basis is recommended for the governmental funds because some of their revenue sources are difficult to measure in advance and frequently become available only a short time before cash receipt

Generally, fair presentation of financial position and results of operations in conformity with generally accepted accounting principles requires that the financial statements of governmental funds (those that use the modified accrual basis) include a balance sheet and a statement of revenues, expenditures, and changes in fund balance In contrast, however, a commercial enterprise would usually prepare a statement of financial position,

an earnings statement, a statement of retained earnings, and a statement of cash flows The statement of revenues and expenditures of the general fund and certain special

C17-2 (continued)

b Inventories are often ignored in governmental accounting because of an emphasis on budgeting revenue against outlays without looking behind the outlays to determine the extent

to which they represent actual usage or consumption Put another way, there is an emphasis

on the cash or fiscal aspects rather than the operational aspects This is easy to understand when one considers that general-fund expenditures for firemen's salaries and for the purchase

of a new fire truck are accounted for in the same way

However, inventories are not wholly ignored in governmental accounting In those funds in which accounting parallels commercial accounting practice, such as enterprise funds, inventories are taken into consideration Similarly, in an internal service fund concerned with rendering service involving the consumption of supplies or the delivery of stores to other funds and activities, the inventories of supplies or stores are taken into consideration in computing billings to departments serviced

Larger amounts of inventories can and should be taken into consideration when preparing budgets A fund, such as a general fund, having departments that possess large inventories at year-end obviously can make smaller appropriations for the coming year than it would if those departments had zero inventories

C17-3 Revenue Issues

The following presentation describes the proper accounting and financial reporting for each item Note that there are two decision points: (1) when a receivable or other asset should be recognized, and (2) when a revenue should be recognized

a GASB 33 states that an asset (receivable or cash) should be recognized for imposed

nonexchange revenue when the government has an enforceable claim to the resources, or the resources are received, whichever comes first The property taxes receivable would be debited at the time an enforceable claim arises In most governments, this is the levy date (sometimes termed the lien date); in some others, it is the assessment date or other date fixed

by law It depends on the enabling legislation permitting the government to impose property taxes Property tax revenue would be credited when the resources become available for use for current expenditures Resources received or recognized as receivables before becoming available for use should have a credit to deferred revenues Recording of both the asset debit and the revenue or deferred revenue credit must be in compliance with the requirements

established by GASB 33 The estimated uncollectible should be recorded as a reduction of

the revenue, and a contra account for the Allowance for uncollectibles should be recorded

b For property taxes received in advance of when they can be used for current expenditures,

a debit is made to cash and a deferred revenue account, for example, property taxes received

in advance, should be credited until the taxes are available for use at which time the deferral should be transferred to revenue

c GASB 33 requires that this derived tax revenue should be recognized as a receivable

when the underlying exchange transaction occurs or resources are received, whichever is first The revenue is recognized when the underlying exchange has occurred and the

resources are available In the rare cases in which derived tax revenues are received before

C17-3 (continued)

d Under GASB 33, this is an example of a voluntary nonexchange transaction unless the

payment is the result of a government-mandated program The asset will be recorded (receivable or cash) when all eligibility requirements are met or resources are received, whichever is first Eligibility requirements are those established by the provider and may state requirements for specific allowable costs or specify a time requirement Revenue will

be recorded when all the eligibility requirements are met On the modified accrual basis, revenues would be recorded when all eligibility requirements are met and the resources are available

e Interest earned on investments is recognized as a receivable in the period in which it is accrued but not yet received But interest is not recognized as revenue until it is considered available to liquidate liabilities of the current period Thus, interest may be accrued to a receivable with a credit to a deferred revenue in the period prior to the actual collection of the interest In addition, the city should make an adjusting journal entry at each balance sheet date to recognize any adjustments required for changes in the fair value of the investments Investment earnings are reported in the revenues section of the operating statement

f GASB 33 specifies that this voluntary nonexchange transaction, with its time restriction

and eligibility requirements, should be recorded as an asset when the applicable eligibility requirements are met or the resources are received, whichever is first Under the modified accrual basis of accounting, revenues should be recognized when all applicable eligibility requirements are met and the resources are available Prior to that, the community may recognize a credit for deferred revenues if the resources have been received

C17-4 Summarizing the Requirements of GASB 34

The following presents a listing of the major points in GASB 34, ―Basic Financial Statements–

and Management’s Discussion and Analysis–for State and Local Governments.‖

a The management’s discussion and analysis (MD&A) is required supplementary information (RSI) but must precede the basic financial statements GASB 34 requires the MD&A to be an objective and easily readable analysis of the government’s financial condition and activities with comparisons to the prior year Not only is management to provide an analysis of the overall financial condition of the governmental entity, but also to discuss significant changes in the funds Also, management should discuss significant budget variances and describe capital asset and long-term debt activities during the year Finally, management is to look forward and describe currently known facts or conditions that may have a significant effect on the government’s future financial condition

b (1) The fund financial statements present the operating results and activities in the individual funds The fund statements reflect the fund-based accountability of the governmental entity as it raises financial resources from the public and expends those resources in meeting the objectives for which each fund is established The governmental funds use a current financial resources measurement focus and the modified accrual basis of accounting Proprietary fund financial statements and fiduciary fund statements use the economic resources measurement focus and the accrual basis of accounting

(2) The government-wide financial statements present the financial position and the fiscal year performance for the governmental entity as a whole All capital assets, including infrastructure assets are included along with a measure of depreciation Long-term debt of the governmental entity is also included in the government-wide financial statements The government-wide financial statements use the economic resources measurement focus and the accrual basis of accounting Thus, even though the fund-based financial statements are the foundation for the government-wide financial statements, a reconciliation schedule must

be provided for the governmental funds to go from the modified accrual basis, to the accrual basis in the government-wide financial statements The government-wide financial statements report program expenses reduced by program resources And net assets on the government-wide statement of net assets are reported for three categories: invested in capital assets net of related debt, restricted, and unrestricted

C17-5 Examining the General Fund Disclosures in a Comprehensive Annual Financial Report (CAFR)

(Note to the instructor: Most local governments now produce a comprehensive annual financial

report You might select the local city or county in which the university is located or a large city close to the university town Printed copies of the CAFR may be obtained directly from that government unit and you could place these copies on reserve in your university or college library for use by your students Alternatively, many governments now provide their CAFRs online A Google web search using ―CAFR‖ and the name of your city, county or state will show if your selection provides an online copy of its CAFR Or, you may do a Google search using ―CAFR‖ and then select one of the government units that provide an online copy of its CAFR and then provide that link to your students or insert that link into your online syllabus.)

C17-5 (continued)

a The budgetary comparison schedules for the general fund are reported as other required supplementary information This schedule for the general fund should be used to answer

questions a and b These schedules disclose the amounts budgeted for each item of revenue,

appropriations for the various functions of government, and for estimated transfers in from other funds and estimated transfers out to other funds in the government

b See the response to question a

c The notes to the basic financial statements should disclose the encumbrance policy—whether the government has a policy in which the outstanding encumbrances lapse at year-end or do not lapse at year-end

d This question reinforces the student’s understanding of the balance sheet equation for the general fund: Assets = Liabilities + Fund Balance This question also makes students aware

of the two forms of fund balance — reserved and unreserved

e This question makes students aware that inventories are reported on the balance sheet of the general fund if the amount is material If reported, the next question is the accounting method for inventories — the purchase or consumption method The notes should answer the policy question

f This question makes students aware of the modified accrual method and its application to property taxes The notes to the financial statements should disclose that revenue from property taxes is reported when measurable and available to finance expenditures of the current period The notes should also disclose the use of the 60-day rule for property tax revenue as well as the percentage of property taxes that were estimated to be uncollectible

g This question focuses attention once again on MD&A and the different items that are reported therein In MD&A, the government’s finance director should explain why revenues in the general fund either increased or decreased during the most recent year

h This question addresses the issue that budgeted inflows and outflows should be compared with the actual resource inflows and outflows for the year Was the budget more or less optimistic in predicting resource inflows from revenues? The same question is appropriate for appropriations versus expenditures This question also should help students understand that the statement of revenues, expenditures, and changes in fund balance reports the change in fund balance that resulted from actual resource inflows and outflows

i This question makes students aware that taxes may be the primary resource inflow for the general fund, but they are not the only resource inflow This question also emphasizes that the revenues of the general fund come primarily from nonexchange transactions

j This question makes students aware of one category of interfund transactions interfund loans and advances The balance sheet of the general fund should report the receivables (―due from‖ or ―advances to‖ accounts) and payables (―due to‖ and ―advances from‖ accounts) associated with any interfund borrowings

C17-6 Examining Deposit and Investment Risk Disclosures of a Governmental Entity

(Note to the Instructor: Students may become frustrated because they may feel that the

information presented in the summaries for GASB 40 and GASB 3 are not enough to fully understand the risk disclosures required by these two standards This case does not require an intensive knowledge, but rather a general knowledge of the required risk disclosures Then the case provides students with the opportunity to see the standards in a real government annual report, especially if they select a local governmental entity with which they are quite familiar, e.g., their home city or the city in which the university is located.)

a The deposit and investment risks stated in the summary are: (1) custodial credit risk; (2) credit risk, (3) concentration of credit risk, (4) interest rate risk, and (5) foreign currency risk GASB 3 and GASB 40, which your students probably would not have, define these as follows:

Custodial credit risk:: (established in GASB 3 but amended in GASB 40): The risk that

in the event of a failure of a depository financial institution or a counterparty to a transaction, a government will not be able to recover deposits, or the value of the investment, or the collateral that is in the possession of an outside party

Credit risk: The risk that an issuer or other counterparty to an investment will not fulfil its

obligations

Concentration of credit risk: The risk of loss attributes to the magnitude of a

government’s investment in a single issuer

Interest rate risk: The risk that changes in interest rates will adversely affect the fair

value of an investment

Foreign currency risk: The risk that changes in exchange rates will adversely affect the

fair value of an investment or deposit

b The summary of GASB 40 stated it well: that the disclosures provide users of the financial statements with information about deposit and investment risks that might affect the ability of a government to provide services and to meet its obligations as they become due

c, d and e These answers will depend on the selected city and most recent fiscal period But, the objective of these three questions is to have students look at the deposit and investment footnotes for an actual governmental entity Students should be able to describe the types of deposit and investment risks faced by the selected local government, its policies

to manage those risks, and the additional financial information such as the investments comprising each portfolio, credit ratings of the investments in bonds, discussion of the impacts

of changing interest rates, and for some governmental entities, discussion of the effects of changing exchange rates for foreign currencies or investments

E17-3 Multiple-Choice Questions on Budgets, Expenditures, and Revenue [AICPA Adapted]

E17-4 Multiple-Choice Questions on the General Fund

1 b

2 d

3 c The balances in the ENCUMBRANCES CONTROL and the FUND BALANCE-

RESERVED FOR ENCUMBRANCES accounts are the same Therefore, an excess of one account over the other indicates a recording error

4 c The following entry is made when a purchase order is approved:

ENCUMBRANCES CONTROL BUDGETARY FUND BALANCE – RESERVED FOR ENCUMBRANCES

5 b The 60-day rule for property tax revenues states that property taxes collected

within 60 days after the end of a fiscal year (within first 60 days of 2007) may be classified as revenues of the prior fiscal year (2006) The entry to record the tax levy would be:

Deferred Revenue (reported as a liability

[Note: The estimated uncollectibles are on the property taxes reported as deferred revenue.]

6 a Upon receipt of the order, Oak would record the following entries:

BUDGETARY FUND BALANCE – RESERVED

7 a Johnson would record the following entry:

ESTIMATED OTHER FINANCING SOURCE –

ESTIMATED OTHER FINANCING SOURCE –

8 c

E17-5 Encumbrances at Year-End

a Outstanding encumbrances lapse at year-end

Close remaining budgeted encumbrances

Reserve actual fund balance for outstanding encumbrances at year-end

(3) City Council accepts outstanding encumbrances—January 1, 20X3:

Fund Balance – Reserved for Encumbrances 21,000

Reverse prior-year encumbrance reserve

Close remaining budgetary encumbrances

Reserve fund balance for outstanding encumbrances

(3) Date the encumbrances from prior year—January1, 20X3::

Fund Balance – Reserved for Encumbrances 21,000 Fund Balance – Reserved for

E17-5 (continued)

(Note: In entry (4), the $800 excess of actual cost over the encumbered amount must be approved as part of 20X3's expenditures Entry (4) records the City Council’s approval with a debit to Expenditures (20X3) which increases 20X3’s total expenditures The expenditures for 20X3 are closed in entry (5) If the actual cost was less than the encumbered amount, then the difference should be closed to Fund Balance-Unreserved, although some governmental units have a policy of closing any difference between actual and encumbered amounts for prior year encumbrances to the current year's expenditures.)

c (1) Outstanding encumbrances are nonlapsing; City Council cancels order—

January 1, 20X3:

City Council cancels 20X2 order for equipment

E17-6 Accounting for Inventories of Office Supplies

a Consumption method of accounting for inventories:

(1) Purchase of supplies:

August 8, 20X2

Acquire inventory of supplies

(2) Entries at end of 20X2 fiscal year:

September 30, 20X2

Recognize ending inventory of supplies

Establish fund reserve for ending inventory

Close expenditures account

Remove fund balance reserve for inventories consumed

Close expenditures account

b Purchase method of accounting for inventories:

(1) Purchase of supplies:

August 8, 20X2

Acquire inventory of supplies

(2) Entries at end of 20X2 fiscal year:

September 30, 20X2

Recognize ending inventory of supplies

Close expenditures account

(3) Entries at end of 20X3 fiscal year: