Essentials of Accounting for Governmental and Not-for-Profit Organizations

Essentials of Accounting for Governmental and Not-for-Profit Organizations Chapter 5: Accounting for Other Government Fund Types -- Capital Projects, Debt Service and Permanent

Overview of Chapter 5 • Review of common characteristics of governmental type funds • Capital Projects Funds • Debt Service Funds • Permanent Fund • Review of Fund statements—Government type funds

Review of Governmental Type Funds • Use modified accrual basis • Long-term asset purchases are treated as expenditures, no depreciation • Generally do not carry long-term assets or long-term liabilities on fund balance sheet • If annual budget is used, may be recorded in fund • If control of purchase orders is relevant to the fund, can use encumbrance accounting

Capital Project Funds • Used for construction or acquisition of major long-term assets such as buildings, bridges, etc. for government funds • Proprietary type funds handle construction activities in proprietary fund, not capital project fund • Accounts for issuance of bonds and receipt of other financing sources • Accounts for construction or acquisition expenditures • Does not carry the long-term asset in the CP fund—Treated as expenditure in the fund • Long-term asset is listed in entity-wide Statement of Net Assets

Primary Sources of Funds for Capital Projects • Issuance of bonds • Grants from other government units • Transfers from other funds • Donations • Interest earned on funds held

Bond Issues • Long-term bonds are not fund liabilities in governmental type funds • If $12,000,000 of bonds are issued you would record Cash $12,000,000 Other financing sources: Bond Proceeds $12,000,000 • Bond proceeds are considered an Other Financing Source on the Statement of Revenues, Expenditures and Changes in Fund Balance • Bond proceeds is not a revenue per se, but is considered an current inflow on the activity statement

Number of CP Funds to Use • Some jurisdictions may require separate CP for each building project • Otherwise, may account for all, or at least related construction projects, in a single fund using the ‘fund within a fund’ approach • Separate accounts for: • Expenditures - Project 1, • Expenditures - Project 2, etc. • General rule—make sure you can prove funds intended to be used on a specific project are traceable to the project

Lease Accounting for state and local governments • Operating leases—true rental situation • Capital leases—these are ‘in-substance’ purchases of long-term assets on time with interest • Criteria to be treated as capital lease are same as for businesses • Transfers ownership • Contains bargain purchase option • Life greater than 75% of asset’s life • Present value of minimum lease payments greater than 90% of fair value of asset

Lease Issues Cont’d • At the inception (beginning) of the lease, the present value is recorded as follows: Expenditure Dr = PV of payments Other Fin. Source – Lease Cr = PV of payments • The Expenditure reports the equivalent of an asset purchase, and the OFS credit shows the equivalent of issuing a long-term note

Capital Leases in Government Funds • A 20-year lease of a building would be considered equivalent to a purchase of the building and payment of a long-term note • In Government type funds using modified accrual • Building purchases are expenditures • Long-term note proceeds are Other Financing Sources • Therefore, the full present value of the building would be treated as an Expenditure when the lease is signed and the full present value of the note would be treated as an Other Financing Source

Lease Issues Cont’d • At the inception of the lease the present value of lease payments is recorded as the value of the asset and of the liability in the entity-wide statements • Over time, the net asset value in the entity wide stmt of net assets is decreased by its accumulated depreciation • Over time, the liability is decreased by the amount of the principal portion included in each lease payment

Special Assessments • “Special” Assessments are similar to property tax payments, but the payer receives direct benefits • Citizens in a limited area may vote or petition the government to provide and charge them for these benefits

Special Assessment Types • Service type: • Example, down town merchants want enhanced police protection and are willing to pay for it through extra assessments • Construction type: • Example, residents want their street paved and are willing to have the cost charged to them over a period of time

Accounting for Service Assessments • The state and local government will use whatever fund they normally use for that service to record the assessment revenue • For example, if the assessment is for extra policing and police costs are in the general fund, then the assessments will be treated as general fund revenues • If the assessment were for service normally accounted for in a special revenue or enterprise fund, then use those funds

Accounting is different for the following two scenarios: The government unit is primarily or secondarily liable to pay off the special assessment construction loan in the event that taxpayer revenues are insufficient The government will NOT hold itself liable, either legally or by choice, in the event that taxpayer payments are insufficient to pay the debt Accounting for Construction Assessments

ConstructionSpecial Assessment Issues • Government liable on the debt • Record construction in CP fund as usual • Record repayment of debt in DS fund as usual • List assets constructed and the special assessment debt in the entity-wide statement of Net Assets • The effect is to treat the debt and related project as if it were undertaken by the government

Construction Special Assessment Issues Cont’d • Government not liable on debt • Debt/bonds not listed in entity wide stmt of Net Assets since it not an obligation of the government • Collections of assessments from taxpayers and remittance to bondholders are handled in an agency fund

Purpose of Debt Service Fund • The debt service fund accumulates resources to pay debt principal and interest on long-term debts of the overall government • DS fund is not used for proprietary fund debts, those funds carry their own long-term debt • While the debt service accumulates money and makes principal and interest payments, bonds payable is not a liability of the DS fund because the DSF uses the modified accrual basis/flow of current resources approach • The Bond Liability is in the entity-wide statement of Net Assets

Sources of DS Financing • Taxes or special assessments earmarked for debt service • Transfers from the General fund • Premiums or accrued interest on bond issuance are often transfer to DSF from Capital Project fund (CPF) • Refinancing bond proceeds • Residual equity transferred from CPF

Modified Accrual Basis & DSF • Exception to expenditure portion of modified accrual definition • Most expenditures are recorded when the liability is incurred • EXCEPT for interest and principal which is record in the DSF as an expenditure when DUE • But, there is an exception to the exception: • Example: When year ends December 31, 20X1 bond payments is due January 1, 20X2 ( or within a month), and the money for the payment was provided in the 20X1 budget—then an expenditure and liability for the upcoming payment may be recorded in fiscal year 20X1 • Key issue—put expenditure in the year it was budgeted

Uses of Debt Service Funds • Sinking fund and payments on term bonds • May use them for serial bond payments, or can be handled in general fund • Payments on long-term notes • Payments on capital lease (but could be in GF)

Types of Debt • For serial bonds, money is moved in, payments made, and little or no balance exists at year end • Because of this simplicity, some governments may actually handle Debt service in General Fund if allowed by law • Term bonds: All the principal of the bond comes due at end of the term (perhaps after 30 years), interest may be paid over time, or all at the end as well • Deferred serial bonds: these may not start the payments for 2 to 5 years after the bonds are used • Allows time for property taxes to begin coming in before payments start

Types of Debt cont’d • In term bond and deferred serial bond situations, the DSF acts as a sinking fund: • Money is moved into the fund and invested in revenue generating investments • Present value techniques and amortization tables are used to plan the amount of money that must be invested so that original money plus revenue earned over time equals required bond principal and interest payments

DSF and Lease Payments • Debt Service Funds are commonly used for capital lease payments, though General Fund may sometimes be used • In DSFs both the payment of principal and payment of interest result in an EXPENDITURE • However, should keep the amounts separate, • Because only the principal portion reduces the net liability on the entity wide Statement of Net Assets

Permanent Funds • Permanent fund characteristics: • A principal amount which is to be invested in perpetuity • Earnings in the fund can be spent for purposes that benefit the government or its citizens • Example: Perpetual cemetery fund set up by citizen donation

Review of Fund Financial Statements for Government Type Funds • Balance Sheet for all Government funds • Must list General Fund, Major Funds, and a single column for nonmajor funds • Okay to show nonmajor funds separately if does not make the reports too cumbersome • Note: Fund Balance shows Reserved and Unreserved

Review Cont’d • Statement of Revenues, Expenditures, and Changes in Fund Balance Will have columns for the same GF, Major, and Nonmajor funds used in Balance Sheet • Format: • Revenues - Expenditures • + or - Other Finance Sources/Uses • + or - Special Items • = Change in Fund Balance • + Beginning Bal = Ending Fund Balance • Note Character Classifications of Expenditures—Current, Debt Service, Capital Outlay

Essentials of Accounting for Governmental and Not-for-Profit Organizations