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  1. 1. CHAPTER 2: PRINCIPLES OF ACCOUNTING AND FINANCIAL REPORTING FOR STATE AND LOCAL GOVERNMENTS OUTLINE Number Topic Type/Task Status (re: 12/e) Questions: 2-1 Governmental activities Describe Same 2-2 Business-type activities Describe Revised 2-3 Fiduciary activities Describe Revised 2-4 Definition of a fund Define 2-5 Revised 2-5 BTA and GAAP Explain 2-7 Revised 2-6 Fund vs. general long-term liabilities Explain 2-9 Revised 2-7 Government-wide financial statements Explain 2-11 Revised 2-8 Measurement focus and basis of accounting Identify New 2-9 Basic financial statements Explain 2-14 Revised 2-10 Component units Define 2-15 Revised Cases: 2-1 Journal articles on GASBS 34 Research New 2-2 CAFRs on the Internet Internet New Exercises/Problems: 2-1 Examine the CAFR Examine Revised 2-2 Various Multiple Choice Revised 2-3 Various True/False 2-5 revised 2-4 Examples of funds Matching New 2-5 Major funds Written Report New 2-6 General capital asset transaction Journal Entry New 16
  2. 2. CHAPTER 2: PRINCIPLES OF ACCOUNTING AND FINANCIAL REPORTING FOR STATE AND LOCAL GOVERNMENTS Answers to Questions 2-1. Certain core services are provided by most general purpose governments—those related to protection of life and property (e.g., police and fire protection), public works (e.g., streets and highways, bridges, and public buildings), parks and recreation facilities and programs, and cultural and social services. Governments must also incur costs for general administrative support such as data processing, finance, and personnel. Core governmental services, together with general administrative support, comprise the major part of what GASB refers to as governmental activities. The measurement focus and basis of accounting for these activities is on the flow of current financial resources on the modified accrual basis in the governmental funds and on the flow of economic resources on the accrual basis in the governmental activities column of the government-wide financial statements. 2-2. The business-type activities of a government include public utilities (such as electric, water, gas, and sewer utilities), transportation systems, toll roads and bridges, hospitals, parking garages and lots, liquor stores, golf courses, airports, and swimming pools among other things. Many of these activities are intended to be self-supporting by charging users for the services they receive. Focusing on economic resources measured on the accrual basis of accounting allows the government to determine whether revenues, such as charges for services, are sufficient to cover the full cost of the activity. This measurement focus and basis of accounting is the same used for reporting governmental activities in the government-wide financial statements, but quite different from the current financial resources measurement focus and modified accrual basis of accounting used in the governmental funds. Those funds emphasize comparing the current year’s financial operations with the annual budget for those activities, a much different objective. 2.3. Fiduciary activities of a government involve the government’s discharge of its fiduciary responsibilities, either as an agent or trustee, for parties outside the government. For example, a government may serve as agent for other governments in the administering and collecting of taxes. These activities are accounted for in agency funds, investment trust funds, pension trust funds, and private-purpose trust funds. Financial reporting for fiduciary activities is done in the fund financial statements, and not in the government-wide financial statements because these assets and related liabilities and net assets do not belong to the government. Fiduciary funds do use accrual accounting and focus on the economic resources of the funds as do business-type activities, but are unlike governmental activities whose primary focus is on the budget and current financial resources. 17
  3. 3. Ch. 2, Answers, 2-4 2-4. A fund is an accounting entity because it has its own self-balancing set of accounts, journals and ledgers to record cash and other financial resources, together with all related liabilities and residual equities or balances, and changes therein. Funds segregate information that accounts for carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations. A fund is a fiscal entity because it has its own resources and liabilities for obligations incurred by the fund and closes out the operating activities in its temporary or nominal accounts at the end of a 12-month fiscal period to facilitate preparation of financial statements. 2-5. Agree in part. Business-type activities and proprietary funds do not have as their objective to make a profit. Rather they exist to provide goods or services on a self- supporting basis, including, if desired, recovery of long-term costs. They are financed and operated in a manner similar to private business enterprises. Matching of revenues and expenses on an accrual basis is useful where (1) the intent of the governing body is to provide goods or services on a continuing basis and the costs are to be financed or recovered primarily through user charges or (2) the governing body has decided that periodic determination of revenues earned, expenses incurred, and/or net income is appropriate for capital maintenance, public policy, management control, accountability, or other purposes. 2.6. Fund long-term liabilities are those that are directly related to and expected to be paid from either the proprietary or fiduciary funds. Proprietary fund liabilities should be reported in the proprietary fund statement of net assets and in the government-wide statement of net assets. Fiduciary fund liabilities should be reported in the statement of fiduciary net assets and not in the government-wide financial statements. General long- term liabilities are all other unmatured long-term liabilities of the governmental unit and should not be reported in governmental funds, but rather should be reported in the governmental activities column of the government-wide statement of net assets. Similarly, fund capital assets are those that are directly related to proprietary or fiduciary funds. All other capital assets of the governmental unit are general capital assets. 2-7. The two government-wide statements, the statement of net assets and statement of activities, should be prepared using the economic resources measurement focus and accrual basis of accounting. 2-8. Governmental fund financial statements focus on the flow of current financial resources and consequently use the modified accrual basis of accounting. This focus puts primary attention on the annual budget and comparing actual revenues and expenditures to those that were budgeted for the year. 2-9. The basic financial statements include the two government-wide financial statements (reporting on governmental activities and business-type activities, as well as any component units) and the seven fund financial statements, with appropriate reconciliations between the governmental fund balances (and changes in fund balances) 18
  4. 4. Ch. 2, Answers, 2-9 (Cont’d) and governmental activities net assets (and changes in net assets) and related notes to these financial statements. In addition, GASBS 34 requires a Management Discussion & Analysis (MD&A) and other required supplementary information, such as a budgetary comparison schedule. 2-10. False. GASB standards indicate that individual component units should prepare separate financial statements and make them available to the public. Reporting financial data of component units with financial data for the component unit(s) reported to the right of those for the primary government, is known as a discrete presentation. Blending is the alternative method if the financial activities of the component unit are so intertwined with those of the primary government that they are, in substance, the same as the primary government. Solutions to Cases 2.1. Each the journals listed has relatively recent articles on the subject of GASBS 34. For example, The Journal of Government Financial Management’s Spring 2002 volume includes an article by Chaney, Mead and Schermann on financial statement analysis of GASBS 34 statements. Public Budgeting and Finance Journal has a special symposium section of its March 2001, Vol. 21, Issue 3 on implications of GASBS 34 on auditors, managers, bond analysts and others. Government Finance Review has an article in its June 2001 Vol. 17 No. 3 on conversion tools for GASBS 34. Encourage students to identify other journals and to describe the likely audience of each journal. 2.2. As time goes by, students should have no trouble locating comprehensive annual financial reports (CAFRs) on the Internet as governments post more information on their websites. At the present time, the GASB includes links to many governments’ CAFRs (see then the “GASB 34” section and then the “Early Implementers” section. Many governments currently include annual financial reports on their websites, for example, the City of Detroit’s CAFR can be found at and then “City Departments,” then “Finance,” and then “CAFR.” Of course website addresses may change so encourage students to use effective key terms with available search engines. Students can refer to these statements as they study Chapters 1 through 10. Solutions to Exercises and Problems 2-1. Each student should have a different governmental annual report, so will have different answers to questions in this exercise. Some time spent in class to allow students to report on their own answers and to get an idea of the range of the answers of other students is useful. Links to reports for governments that have implemented GASBS 34 can be found at, then “GASB 34” section, and then “Early Implementers.” 19
  5. 5. Ch. 2, Solutions, 2-2 2-2. 1. b. 6. a. 2. b. 7. d. 3. c. 8. b. 4. d. 9. d. 5. b. 10. b. 2-3. 1. F. Permanent funds are also included in the governmental fund category. 2. F. The focus of proprietary funds is on total economic resources. 3. T. 4. F. Fiduciary funds focus on total economic resources using full accrual accounting and do not incorporate budgetary accounts. 5. F. Depreciation of general capital assets should be reported in the government- wide statement of activities. General capital assets and related accumulated depreciation should be reported on the government-wide statement of net assets. 6. T. 7. T. 8. F. The test for major funds also includes being greater than 5% of the corresponding total of both governmental and proprietary funds. 9. F. Blended component units and component units of a fiduciary nature are also shown on the fund financial statements. 10. T. 2-4. 1 k. 7. e. . 2 a. 8. i. . 3 j. 9. f. . 4 g. 10. c. . 5 b. 11. h. . 6 d. . 2-5. DATE: xx MEMO TO: City Manager, Township of Coldwater FROM: External Auditor RE: Major Special Revenue Funds The Housing and Urban Development Grant and Forfeiture Act Funds should be considered major funds, but not the Gas Tax Revenue Fund. None of the four elements of the Gas Tax Revenue Fund (assets, liabilities, revenues, or 20
  6. 6. expenditures) are greater than 10% of the corresponding total of all governmental funds and greater than 5% of the corresponding total of all governmental and proprietary funds. The revenues of the Housing and Urban Development Grant are just over 11% of all governmental funds and just over 5% of all governmental and proprietary funds. The Forfeitures Act fund is likely one that is particularly important to financial statement users because of recent attention in the press, and Ch. 2, Solutions, 2-5 (Cont’d) consequently, management may decide that it is useful to present this fund as “major” so information about it is readily available to readers. 2-6. General Fund: Debits Credits Expenditures – Capital Outlay 10,000 Cash 10,000 Governmental Activities: Equipment 10,000 Cash 10,000 The General Fund focuses on current financial resources and matching actual expenditures to that which was budgeted. As a result, modified accrual precludes the General Fund from capitalizing equipment as a noncurrent asset; rather, it is considered an expenditure of the period. On the other hand, governmental activities at the government-wide level focuses on total economic resources and accrual accounting does require long-lived capital assets to be capitalized and reported as “Equipment” or “Capital Assets” on the statement of net assets. 21