Week # 5

1. Week # 5 Accounting and Financial Reporting

2. IntroductionAccounting and Financial Reporting Chapter 4 introduced the concept of financial controlemployed by local government noting there are three interdependent systems of financial control: (1) Budget Implementation (2) Accounting (3) Financial Reporting Budget Implementation was the focus of the preceding session focused. During this session the focus will be the two other sources of financial control --- AccountingandFinancial Reporting.

3. It should be noted at the outset of this session that the budget document actually provides both a foundation and framework for an accounting system.

4. Accounting and Financial Reporting Q5-1: Identify and briefly describe the primary purpose of the accounting system used by local government. Q5-2: Identify at least two ways the budget document provides the foundation for accounting control.

5. An Accounting System provides the methods and means to compile data for Financial Reports which … • summarize accounting information • allow monitoring of revenue collection and spending during the fiscal year • provide the means to control spending and make necessary corrections.

6. The Accounting System An Overview • Provides the record-keeping framework in which transactions authorized by the budget are logged. • Every transaction is recorded and aggregated into interim financial reports and distributed to local government managers to facilitate financial control. • At year-end, all transactions are compiled into a standardized format called the comprehensive annual financial report (CAFR).

7. Purpose of Financial Reports Q5-3: Briefly describe the purpose served by interim financial reports and the comprehensive annual financial report filed at the end of each fiscal year and identify one or more persons or groups who would be interested in receiving the information contained in these reports.

8. The Accounting SystemAn Overview An accounting system provides…. • Reliable information regarding the financial position of local government throughout the year (how much money has been collected or spent). • Helps identify trouble spots (when spending is getting out of control or collections are lagging behind). • Helps to identify when corrective measures must be taken (fund transfers, amendments, use of budget reserves).

9. Generally Accepted Accounting Principles (GAAP) • ACCURACY is the FIRST requisite of any accounting system!!! • For this reason, the accounting profession adopted a common set of standards several decades ago known as Generally Accepted Accounting Principles (GAAP Principles). • The GAAP Principles ensured transactions would be recorded the same way by any organization – in any jurisdiction - at any time. • CONSISTENCY in recording/reporting of financial data is essential to the integrity of an accounting system --- and any financial records or reports that may be derived from any accounting system. • Standardized formats and reporting protocols make possible external review of financial records by auditors and other stakeholders.

10. GAAP Principles The adoption of GAAP Principles provided the accounting profession with the means to achieve the below listed six goals with respect to the recording and reporting of financial information. Understandable Reliable Relevant Comparable Consistent Timely

11. GAAP Principles Q5-4: Review the list of six GAAP goals and select the three goals that you think a public sector manager would consider to be the most important and support your selection by briefly explaining the importance of those particular goals.

12. The Government Accounting Standard Board The six GAAP goals provided the conceptual basis for the 13 GAAP Principles adopted by the Government Accounting Standards Board in 1984. Turn to Page 108 and review the summary of the 13 GAAP Principles adopted for governmental accounting.

13. Standardization of Accounting Systems The text described and differentiated the basis for accounting systems used by the private sector and public sector and provided information on the following three: > Accrual Basis of accounting > Modified Accrual Basis of Accounting > Cash Basis of Accounting

14. Accrual Basis of Accounting The accrual basis of accounting is used in the private sector while the modified accrual basis of accounting is primarily used in the public sector. • One easy way to understand the difference is to realize the public sector does not EARN revenues by producing and selling goods or services (i.e., the public sector is not profit driven). • The public sector “collects revenues” to pay for the expenditures that must be made for public services or public goods. • Therefore - no direct link exists between the cost of production and revenue.

15. Accrual vs. Modified Accrual • In accrual accounting …revenues from the sale of products are recognized when they are both earned and measurable, and expenses for raw materials and labor are recognized when they are used in the production process. The focus of the accrual system is net income --- or said another way ( Income = Revenues – Expenses ) • In the modified accrual basis of accounting … local government waits until revenue is available and measurable before recording it --- that is --- when they know how much and when revenue will be received.

16. Modified Accrual Basis of Accounting • In the public sector --- it is far more important to know if revenues received from taxes and other sources during a given fiscal period are sufficient to cover expenditures for that fiscal period. • Lawmakers and public sector managers must constantly monitor the financial condition of local government to ensure a fund’s current assets equal or exceed its current liabilities.

17. FUND STRUCTURE

18. Fund Structure • The private sector combines the results of the operations of all subsidiaries into one consolidated report. • The public sector disaggregates its operations into funds and creates a separate report for each fund. • There are eleven (11) different types of fund commonly used by local government. (See Page 110 – Figure 5-3.)

19. Fund Structure • Fund (defined) --- > A fund is an accounting entity with a self-balancing set of accounts. > Governmental accounting information is organized into funds, each with separate revenues, expenditures (or expenses) and fund balances.

20. Fund Structure • Each fund… • operates as though it were a self-contained business • receives revenues from a different source • spends money for different purposes • maintains its own set of accounts and financial reports.

21. Proprietary funds Enterprise funds Internal service funds • Governmental • Funds • 3 categories • 11 types Governmental Funds • General funds • Special service funds • Debt Service Funds • Capital projects funds • Permanent funds Fiduciary Funds • Investment trust funds • Private-purpose trust funds • Pension trust funds • Agency funds

22. General Fund • Usually the largest and most important. • Primary operating fund - and the most important in terms of operating budget. • As the name implies – any transaction that cannot be accounted for in another fund must be recorded in the General Fund.

23. Special Revenue Funds • Special Funds – as the name implies – are established to account for proceeds of revenue sources earmarked for a particular or “special” purpose. • Funds are restricted to a specific purpose and the “special” fund allows funding to be segregated and spending to be restricted to that special purpose. • While there is only one General Fund there may be several Special Funds (e.g., Hotel/Motel Tax Fund, City Parks Beautification Fund, etc.)

24. Debt Service Funds • This fund is used to account for resources used to pay the principal and interest on long-term debt, such as a general obligation bond. • This fund segregates the funds that will be used to repay debt AND to demonstrate sufficient funds have been set aside for this purpose. • Local government may have one or more debt service funds for specific sources of debt. • Also known as “sinking funds” because the funds are used for sinking (retiring) debt.

25. Capital Projects Funds • This fund is used to account for all resources used to construct and acquire capital facilities or infrastructure. • Revenues may come from a variety of sources, such as taxes, bonds, state or federal grants. • This fund allows all revenues and expenditures for these large capital projects to be segregated from other funds. • Segregating capital funds also allows the expenditure for a particular project to be monitored and better managed. • Once the project is complete, the fund is closed and any remaining balance is transferred elsewhere.

26. Permanent Funds • Permanent Funds constitute endowments made to local government for a special purpose, such as a fund to purchase library books. • The endowment principalmust not be expended – only the income earned from the endowment may be spent (e.g., interest). • Provides a means to segregate these funds and ensure compliance with spending restrictions.

27. Proprietary Funds • There are two kinds of proprietary funds: > Enterprise funds > Internal service funds • Proprietary funds are used to account for the businesslike activities of local government such as city utilities (e.g. water service). • The accrual basis of accounting is used because both types of proprietary fund receive revenues primarily from customer charges which can be directly related to the production costs to provide the service - much like any business enterprise.

28. Enterprise Funds • Enterprise Funds account for services that are substantially supported by customer fees such as public utilities (e.g., city water service). • The use of Enterprise Fund(s) and the accrual basis of accounting for these funds make it possible to determine whether each enterprise is bringing in enough revenue to pay all of costs to provide the customer service.

29. Internal Service Funds • Used to account for goods and services produced by one department and provided to another department of local government on a cost-reimbursement basis. • For example, the Graphic Arts Department will charge another department for reproduction services. • It is not uncommon for departments who plan to use such services to include a line-item in the budget to pay for such services during the year. • Internal Service Funds make it possible to monitor costs and how much other department use certain services such as use of motor pool vehicles.

30. Fiduciary Funds • Account for resources that governments hold in trust for individuals or other governments. • There are four types of fiduciary funds: Investment Trust Funds Private-purpose Trust Funds Pension Trust Funds Agency Funds

31. Investment Trust Funds Funds from various governments that are comingled such as County-Wide Pool Fund. Allows an accounting of funds received from various sources and also expenditures made from the fund. Each stakeholder can then examine revenue and expenditures.

32. Private-purpose Trust Funds • Have a similar fiduciary relationship in that the government holds resources in trust on behalf of individuals, a private organization or even other governments. • For example, a scholarship fund provided by a private organization for the education of children of fallen police officers.

33. Pension Trust Funds • Funds contributed by employees and also government for the retirement of their employees. • Accounts for all contributions, investments and pay outs.

34. Agency Funds • This fund accounts for the collection of taxes and fees for other governments, such as the state collecting sales tax and remitting a portion to local government. • Allows collection and distribution of funds during a fiscal period.

35. ACCOUNTS

36. ACCOUNTS Funds are the basic building blocks of governmental accounting --- and --- funds are made up of accounts An account is defined as a “separate financial reporting unit for budgeting, management and/or accounting purposes”. Every transaction, starting with the adoption of the budget, is recorded in an account. Budgetary accounts -- the estimated revenues and appropriations -- link the budget and accounting systems and form the cornerstone of the accounting records.

37. ACCOUNTS Each account is given a unique number that identifies the fund in which the account is found and the type of account it is – such as cash, supplies, taxes receivable, accounts payable, etc. Example of Account Numbering system: 100-201-3010-2100 (See Figure 5-6 on Page 116)

38. Kinds of accounts • In the budget --- there are two kinds of accounts: (1) Estimated revenues (2) Appropriations • Each source of revenue and each type of appropriation is given a separate account number.

39. Three Additional Account Types While there are two types of budgetary accounts (i.e., estimated revenues and appropriations), the accounting system has three additional types of accounts that form the basic accounting equation: Assets = Liabilities + Fund Balance

40. Asset Accounts • A type of account that records information on things of value to the fund. • Asset accounts are of two general types: • Current assets – such as cash or things that can be converted fairly quickly (e.g., investments, receivables and inventory) • Fixed assets – such as things of value with a life expectancy of more than one year (e.g., land, buildings and equipment)

41. Liability Accounts • A type of account that contains information on claims to the fund’s assets, either by other funds of the local government or by external entities. • Liabilities represent legal obligations that require transfer of assets to satisfy the obligation. • Said another way --- as liabilities come due (e.g., accounts payable, bonds payable), then cash and other assets are transferred to the claimant to satisfy the claim.

42. Liability Accounts • The delivery of a piece of equipment creates a liability and eventually requires the transfer of cash to the vendor. • Each day an employee works, a liability is incurred that requires the transfer of cash in the form of salary top satisfy the obligation.

43. Assets = Liabilities + Fund Balance • It should be noted --- > the delivery of a piece of equipment creates a fixed asset on the left-hand side of the accounting equation AND > a corresponding liability on the right-hand side of the accounting equation.

44. Fund Balance In the private sector, net assets represent the wealth accumulated by a business as a result of its operations which is determined by calculating the difference between assets and liabilities. In the public sector, the purpose is not to accumulate wealth but to deliver services and the difference between a fund’s assets and its liabilities is the fund balance. • Said another way --- the fund balance is located on the right-hand side of the accounting equation and when added to liabilities it equals the assets of a fund. Assets = Liabilities + Fund Balance

45. Three Components of the Fund Balance (1) Reserved Portion (2) Designated Portion (3) Undesignated Portion

46. Three Components of the Fund Balance The reserved portion of the fund balance represents net financial assets not available for appropriation because they have been legally committed to some future use. The unreserved portion of the fund balance represents money that is available for appropriation in the next period. The unreserved portion is divided into the designated and undesignated portions of the fund balance. The designated portion of the fund balance includes resources earmarked for some purpose such as a rainy day account or pending litigation. The undesignated portion of the fund balance has no reservations or management designations and is available for re-appropriation.

47. Chart of Accounts • As you will recall, three GAAP requisites for an accounting system is to render information that is: understandable, comparable, and consistent. • The Chart of Accounts provides a common framework to identify each Fund – Department – Account - Object of Expenditure used in both the budgeting and accounting system for a local government. By requiring all units of a local government to use a common terminology and common numeric coding system, account information can easily be moved from the budget to the accounting system and back again.

48. Chart of Accounts Example: Accounting for Salary Payments The following code number (100-210-3010-2100) illustrates how a salary expenditure would be coded to record a salary payment by the Budget Office, a unit within the City Manager’s Finance Office, using money drawn from the general fund: Fund Department Sub-agency Expenditure/Revenue Code Code Code Code 100 201 3010 2100 General FundFinance Budget Office Salaries

49. Chart of Accounts • The system for numbering accounts is essentially similar across local governments. • However, each local government has some peculiarities and therefore each will vary somewhat from jurisdiction to jurisdiction. • Most importantly, the commonality of the Chart of Accounts allows information contained in the budget and accounting systems to be linked and also for the information to be understandable, comparable and consistent within one local government and from jurisdiction to jurisdiction.

50. Reconciling the Budget with Accounting Data • The heart of the accounting system is the recording and reconciling of transactions! • Each transaction generates some type of documentation. • The data from each financial document leads to an entry in a journal to maintain a general record of all transactions. • The journal data is later compiled and used as the basis for other accounting reports to summarize on-going financial activity.