Learning objectives

• Determine the unique role of budgets in the governmental environment.
• Distinguish how budgets are recorded in the accounting system.
• Determine what encumbrances are and how they are used.
• Identify how budget information is reported in the financial statements.

No taxation without representation

What does that historic phrase have to do with budgets? A great deal, as it turns out. Many services of government are paid for with taxes, something most people have to pay. However, only people who we elect can impose those taxes on us. They also are the ones who decide how those resources are to be spent by legally adopting a budget. Governments must show that they spent resources only for purposes approved by our elected officials.

The role of budgets

Why are budgets so important in government? The answer is that budgets are based on the historic notion of “no taxation without representation.” Governments can raise taxes only for purposes approved (appropriated) by the elected representatives of the people.

Matters related to the budget are some of the most important decisions that elected officials make. Generally, it is a legally adopted budget that confers authority to levy taxes and spend money. The budget process typically lasts for months and involves public hearings. Elected officials have to balance the need for services against how much taxpayers are willing to provide.

Once approved, budgets become legal contracts between the government and its citizens. Elected officials formally pass an appropriation act, resolution, or ordinance (approved revenues and expenditures), giving government legal authority to spend money. Government officials must demonstrate compliance with legal budgets as part of their financial reporting. Budgets consist of both estimated revenues and appropriations. Although the budget for estimated revenues is often used to set tax rates, it does not have the same legal impact as appropriations. Most governments cannot legally exceed appropriations.

Although all funds may have budgets, they play a special role for governmental funds. Typically, services provided by governmental funds are paid for by taxes; there is often little relationship between the revenues generated and the services provided. Elected officials decide how tax revenues are going to be spent when they approve budgets for governmental funds.

Budgets for the businesslike activity of proprietary funds are usually flexible and often not legally adopted. For these activities, there is a relationship between revenues and expenses. Elected officials are usually more concerned with rates charged by business-type activities than the amount of projected expenses. For example, if an activity generates more revenues than projected, it is likely to also generate more expenses.

Governments adopt an annual budget, which in most cases is for the general fund. Special revenue funds also normally have legal budgets. Legal budgets for debt service funds are less common because debt covenants often specify payment requirements. Capital project funds are usually budgeted on a project basis and often have no annual appropriated budget. Generally, permanent funds also do not usually have legally adopted budgets.

Budgets for governmental funds may be approved on some basis other than generally accepted accounting principles (GAAP). For example, a budget can be developed on a cash basis or a budget may include commitments to acquire goods or services before the end of the year (encumbrances). For reporting purposes, a presentation that compares budgeted amounts to actual amounts should report the actual amount of revenues and expenditures on the same basis as the budget.

Budgets can be approved at any level of management control. For example, the budget can be approved at the fund, function, department, activity, or object level. The more detailed the level of management control at which the budget is approved, the less flexibility the government has in reallocating resources internally. A balance should be achieved between legal budgetary control and efficient management control.

Encumbrances

Government managers use budget information to monitor spending. The available appropriation, which represents the amount of the current appropriation remaining to be committed or spent, can be arrived at by subtracting actual expenditures and outstanding commitments from the appropriated amount. Subtracting both actual expenditures and outstanding commitments provides a better indication of what amount is available to spend.

Governments often use encumbrances to record outstanding commitments in the accounting system. An encumbrance does not represent a liability or expenditure; it is a budgetary tool used to control spending. Amounts are usually encumbered when goods or services are ordered. When the goods or services are received, the encumbrance is removed and the actual expenditure and liability is recorded.

Encumbrances usually represent purchase commitments and, often, are only estimates of the costs of goods or services to be received. The actual cost for the goods or services received may differ from the encumbered amount. When this happens, the encumbrance should be removed for the same amount at which it was established and the expenditure recorded for the actual amount.

For example, assume a government orders goods estimated to cost $15,000. In a manual system, an encumbrance is recorded as follows:

When the item is received, the encumbrance is removed and the expenditure recorded. Assuming that the actual invoice for the preceding encumbrance is for $14,990, the entry to record this transaction is as follows:

Note that the encumbrance is removed for the same amount that it was established, and the expenditure is recorded at the actual amount.

Encumbrances can be very useful in controlling expenditures. Governments can choose to use an encumbrance system that is efficient and effective for their needs. For example, governments can require encumbrances for purchases only over a certain amount. Often, governments will not encumber salaries and other routine expenses such as utilities. Some governments do not use an encumbrance system at all.

Outstanding encumbrances at the end of the year are typically removed as part of the budgetary closing procedures. In a manual system, outstanding encumbrances can be removed by reversing the original entry. An outstanding encumbrance of $10,000 would be removed as follows:

Governments establish various policies regarding outstanding commitments at year-end. Some consider all outstanding commitments to be canceled. Some intend to honor outstanding commitments but require that the appropriation for the next year include these items. Still others consider outstanding encumbrances to be an appropriate charge against current-year appropriations.

Prior to the issuance of GASB Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, in cases where encumbrances represented a charge against current-year appropriations, the government would reserve fund balance for the amount of outstanding encumbrances. With the advent of GASB Statement No. 54, amounts related to outstanding encumbrances at year-end are no longer reported as a separate line on the face of the balance sheet. Significant encumbrances are disclosed in the notes to the financial statements.

Comparing budgeted amounts to actual amounts

Accountability requires governments to demonstrate their compliance with legally adopted annual budgets. To do this, governments must report budgetary comparison schedules for the general fund and for each major special revenue fund with a legally adopted annual budget.

Budgetary comparison schedules are schedules that are reported as part of required supplementary information (RSI). RSI is unaudited information included with governmental financial statements. However, governments may elect to include these schedules as part of the fund financial statements. In this case, the budgetary comparison schedule becomes subject to the same audit requirements as other fund-based statements. An example of a budgetary comparison schedule is in appendix B.

These schedules must contain at least three columns for each governmental fund reported:

1. A column for the original budget, the first complete appropriated budget (amount may include adjustments made to the budget before the beginning of the fiscal year; also, actual appropriation amounts that automatically carry forward from prior years should be included)
2. A column for the final budget (with all amendments and revisions)
3. A column for actual amounts reported using the budgetary basis of accounting

A variance column may be included to facilitate the comparison of budget and actual amounts; however, this column is not required.

The budget may be prepared on a basis other than GAAP. In this case, the actual amount reported for revenues and expenditures is reported on the same basis as the budget. This does not change the requirement that the statement of revenues, expenditures, and changes in fund balance be prepared on a GAAP basis of accounting.

Any differences between the statement of revenues, expenditures, and changes in fund balance and the budgetary comparison schedule must be reconciled. This can be done on the face of the schedule or in the notes to RSI.

The budget comparison schedule can be prepared using the same format and terminology of the budget document or using the same format as the statement of revenues, expenditures, and changes in fund balances. If expenditures exceed budgeted amounts for an individual fund, this information must be disclosed.

Some governments have significant budgetary perspective differences that result in their inability to present budgetary comparisons for the general fund and each major special revenue fund. These governments are required to present budgetary comparison schedules as RSI based on the fund, organization, or program structure that the government uses for its legally adopted budget.

Summary

Budgets play a special role in governments. Once approved, budgets become legal contracts between a government and the citizens it serves. Elected officials formally pass an appropriation act, resolution, or ordinance, giving the government legal authority to spend money. Legally adopted budgets are used for the general fund and often for other governmental funds.

To ensure budgetary control, budgets are often recorded in the accounting system. Many governments also use encumbrances as a budgetary tool to record commitments against budgets. Governments are required to report a budgetary comparison schedule with their financial statements. This schedule is usually reported as part of RSI or can be reported as part of the fund financial statements.

Budgets can be prepared on some other basis than GAAP. The actual amount of revenue and expenditures in the budgetary comparison schedule is reported on the same basis of the budget. If the basis is other than a GAAP basis, a reconciliation of the two bases is required.

Practice questions

Please note that the following practice questions are not required reading material.

1. What is the legally adopted budget for expenditures called?
   1. Estimated expenditures.
   2. Appropriations.
   3. Allotments.
   4. Encumbrances.
2. A flexible budget would be typically used for which fund?
   1. General fund.
   2. Enterprise fund.
   3. Special revenue fund.
   4. All the above.
3. In recording the adoption of a budget for a general fund, a debit amount is recorded to budgetary fund balance. What does this entry indicate?
   1. Estimated revenues exceed appropriations.
   2. Appropriations exceed estimated revenues.
   3. The budget is balanced.
   4. Revenues exceed expenditures.
4. What should the entry to record adoption of a general fund budget include?
   1. A debit to estimated revenues.
   2. A credit to estimated revenues.
   3. A debit to appropriations.
   4. Both (b) and (c).
5. Entries to the appropriation account would be made when
   1. The expenditure budget is revised.
   2. The budget is recorded.
   3. The budget is closed.
   4. All the above.
6. To record an encumbrance, which account is debited?
   1. Expenditures.
   2. Appropriations.
   3. Encumbrances.
   4. Reserve for encumbrances.
7. A budgetary comparison schedule is required for which?
   1. All governmental funds with annual enacted budgets.
   2. The general fund.
   3. Each major special revenue fund with an annual enacted budget.
   4. Both (b) and (c).
8. A general fund ordered supplies with an expected cost of $3,000. This amount is encumbered. The supplies are received with an invoice of $3,100. The entries to record the receipt of the supplies should include a debit to what account?
   1. Encumbrances of $3,100.
   2. Expenditures of $3,100.
   3. Reserve for encumbrances of $3,000.
   4. Both (b) and (c).
9. A budgetary comparison schedule should be reported as part of which?
   1. Fund financial statements.
   2. Notes to the financial statements.
   3. RSI.
   4. Either (a) or (c).
10. Explain the difference between an expenditure and an encumbrance.

     

     

11. Where in the financial statements may the budgetary comparison schedules be presented? Explain the impact that placement will have on the audit.

     

     

12. A city approves an expenditure budget in the amount of $25,000. The city encumbers two items. The first item is an order for supplies in the amount of $6,000; the second item is an order for parts in the amount of $2,500. The first order is received at a cost of $5,800. What is the amount of available appropriation? What does this represent?