Chapter 2
Fund Accounting and the Financial Reporting Model

Learning objectives

  • Recognize funds and identify why they are used.
  • Determine how many funds are needed.
  • Recognize the fund structure used by governments.
  • Recognize the financial reporting model used by governments.

Reporting two ways: Fund and government-wide statements

Governments report financial activities in two ways: by fund and for the government as a whole.

Fund fundamentals

Funds

Before we explicitly define fund, we must understand why governments use funds. One reason is because governments receive resources from a variety of sources for a variety of purposes. For example, a city may receive resources from the state to maintain roads or from the federal government to run a reading program. Governments may also hold restricted resources for such things as employee pensions or a reserve for future debt payments. Governments must be able to demonstrate that they are using resources for the purposes for which they were given.

In addition, governments are engaged in a diverse range of activities with different operating objectives. For example, many activities are provided without direct charge (for example, police service), whereas some services are set up to recover full costs (for example, water and sewer services). Governments will want to separately measure these types of activities to see if they are meeting their different financial objectives.

To meet the overall objective of accountability, governments must be able to demonstrate compliance with legal and other restrictions placed on resources and be able to properly measure the costs of different activities. To do this, governments use several smaller accounting entities — funds — to provide financial information. Fund accounting provides the means to report financial activities based on different legal requirements and operating objectives.

The GASB defines a fund as follows: “A fund is defined as a fiscal and accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equities or balances, and changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations.”

This definition contains several important concepts. First, funds are not separate legal entities but are created by accounting. The “self-balancing set of accounts” concept relates to the fact that each fund will record activity under its own accounting equation; therefore, separate financial statements can be prepared for each fund. Financial reporting by governments emphasizes the activities of funds and fund types. The final part of the definition gives several reasons for having separate funds.

Number of funds

How many funds does a government need? Will 5, 10, 20, or even 50 be enough? It depends. Often, an accounting system is able to track several different activities within one fund. For example, a government may use one fund to account for all federal restricted operating grants. Another government may set up a separate fund for each major grant. What is important is that both governments must be able to demonstrate that they used the resources in compliance with any restrictions placed on them. In addition, separate funds must sometimes be used because of accounting or legal requirements. The following rule should be used to determine the number of funds: In general, a government should use the minimum number of funds necessary for sound financial management and to meet legal and accounting requirements.

As the number of funds increases, so do the complexities in budgeting, accounting, and other administrative matters; at the same time, flexibility decreases. An organization must maintain a balance between too many and too few funds. Therefore, the number of funds that a government should use becomes a matter of professional judgment.

All governments need at least one fund, its “general fund.” Whether to use additional funds is a matter of legal requirements and professional judgment.

Creating a new fund

A government can establish a new fund at any time. For example, a new fund may be mandated by new accounting standards or a change in a state’s constitution. A grant or other restricted revenue source may also require the creation of a separate fund. Also, a government may start a new activity that it wants to track separately.

A new fund should be established when legally required or when new accounting standards are promulgated. In other cases, management needs to determine whether the desired level of financial control and management can be achieved by accounting for an activity within an existing fund or whether a separate fund is required.

Fund structure

Government activities are diverse and can be grouped into three broad categories: general activities of the government financed primarily by taxes and grants, business-type activities financed primarily by user fees, and activities where the government performs the role of an agent or under a trust agreement. Accordingly, funds used by a governmental organization fall into the following three categories:

  1. Governmental funds. These are used to account for the general operations of a government. The emphasis of financial reporting is on the flow of expendable financial resources. The accounting is designed to measure the change in available financial resources, as opposed to “net income.” Governmental funds are supported primarily with taxes.
  2. Proprietary funds. These are used to account for the business-type operations of a government. The emphasis of financial reporting is like that of a business. The accounting is designed to measure operating income, financial position, and cash flows. Proprietary funds are supported primarily with fees for services.
  3. Fiduciary funds. These are used to account for resources established under a trust agreement or a custodial relationship. These resources cannot be used to support a government’s own programs. The accounting is designed to measure resources held for others and changes in those resources.

Within these three major categories of funds, 11 different types of funds can be used. All funds used by governments are defined as 1 of the 11 fund types. Often a government can have more than one fund of a particular type or, in some cases, have no funds of a particular type.

The following illustration shows the 11 fund types grouped by fund categories.

image

Governmental funds

  1. General fund. This is used to account for and report all financial resources not accounted for and reported in another fund.
  2. Special revenue funds. These are used to account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for specified purposes other than debt service or capital projects. The term proceeds of specific revenue sources establishes that one or more specific restricted or committed revenues should be the foundation for a special revenue fund.

    Those specific restricted or committed revenues may be initially received in another fund and subsequently distributed to a special revenue fund. Those amounts should not be recognized as revenue in the fund initially receiving them; however, those inflows should be recognized as revenue in the special revenue fund in which they will be expended in accordance with specified purposes. Special revenue funds should not be used to account for resources held in trust for individuals, private organizations, or other governments.

    The restricted or committed proceeds of specific revenue sources should be expected to continue to make up a substantial portion of the inflows reported in the fund. Other resources (investment earnings and transfers from other funds, for example) may also be reported in the fund if those resources are restricted, committed, or assigned to the specified purpose of the fund. Governments should discontinue reporting a special revenue fund and instead report the fund’s remaining resources in the general fund if the government no longer expects that a substantial portion of the inflows will derive from restricted or committed revenue sources. Governments should disclose in the notes to the financial statements the purpose for each major special revenue fund, identifying which revenues and other resources are reported in each of those funds.

  3. Capital projects funds. These are used to account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays, including the acquisition or construction of capital facilities and other capital assets. Capital projects funds exclude those types of capital-related outflows financed by proprietary funds or for assets that will be held in trust for individuals, private organizations, or other governments.
  4. Debt service funds. These are used to account for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest. Debt service funds should be used to report resources if legally mandated. Financial resources that are being accumulated for principal and interest maturing in future years should also be reported in debt service funds.
  5. Permanent funds. These are used to account for and report resources that are restricted to the extent that only earnings, and not principal, may be used for purposes that support the reporting government’s programs; that is, for the benefit of the government or its citizenry. Permanent funds do not include private-purpose trust funds, which should be used to report situations in which the government is required to use the principal or earnings for the benefit of individuals, private organizations, or other governments.

Proprietary funds

  1. Enterprise funds. These are used to account for operations that are financed and operated in a manner similar to a business enterprise, in which fees are charged to external users for goods and services.
  2. Internal service funds. These are used to account for activities that provide goods or services to other funds, departments, or agencies of the primary government and its component units, or to other governments, on a cost-reimbursement basis.

Fiduciary funds

GASB Statement No. 84, Fiduciary Activities, which is effective for fiscal years beginning after December 15, 2018, establishes criteria for identifying and reporting fiduciary activities. The criteria for identifying fiduciary activities primarily focus on (a) whether a government controls the assets of the fiduciary activity and (b) the beneficiaries with whom a fiduciary relationship exists.

Governments with activities meeting the criteria will present a statement of fiduciary net position and a statement of changes in fiduciary net position, with certain exceptions.

It is important to note that agency funds will no longer be reported under GASB Statement No. 84.

  1. Pension (and other employee benefit) trust funds. These are used to account for resources for pension plans and postemployment benefit plans other than pension plans that are administered through qualifying trusts and other employee benefits plans for which resources are held in a trust meeting specified criteria and contributions to the trust and earnings on those contributions are irrevocable.
  2. Investment trust funds. These are used to account for the external portion of investment pools and individual investment accounts that a government holds in a trust or equivalent arrangement that meets specific criteria.
  3. Private-purpose trust funds. These are used to account for all other trust agreements meeting specific criteria for which the government itself is not a beneficiary that are not required to be reported in pension (and other employee benefit) or investment trust funds.
  4. Custodial funds. These are used to account for fiduciary activities that are not required to be reported in pension (and other employee benefit) trust funds, investment trust funds, or private-purpose trust funds. Custodial funds should report fiduciary activities that are not held in a trust or equivalent arrangement that meet specific criteria. The external portion of investment pools that are not held in a qualifying trust should be reported in a separate external investment pool fund column, under the custodial fund classification.

A government is not required to report all 11 fund types. As stated earlier, the number of funds that a government should use becomes a matter of professional judgment. Many activities of a government can be accounted for in the general fund; separate funds can be used if needed to increase accountability. However, a government should use the minimum number of funds necessary for sound financial management and to meet legal and accounting requirements. There are only a few instances where generally accepted accounting principles requires the use of specific funds to report certain activities. It is important to note that all governments should have a general fund and there can be only one general fund.

Knowledge check

  1. Which statement is correct regarding the creation of new funds?
    1. A grant or other restricted revenue source may require the use of a separate fund.
    2. Governments never start a new activity that they want to track separately.
    3. The governing board cannot create a new fund at any time during the year.
    4. A new fund can be created only at the start of the year.
  2. Which statement is accurate regarding fiduciary funds?
    1. Investment trust funds are used to account for the external portion of investment pools reported by sponsoring governments.
    2. Private-purpose trust funds are governmental funds.
    3. Private-purpose trust funds are used to account for resources held by the government in a purely custodial capacity.
    4. There are five types of fiduciary funds.

Overview of the financial reporting model

Before we move on, a basic understanding of the reporting model used by state and local governments would be useful. Remember that accountability is the key financial reporting objective and that fund accounting is one method used to fulfill this objective. One aspect of financial reporting by governments is an emphasis on the activities of funds and fund types. However, governments must also provide financial information about the results of operations and financial condition of the overall government. To meet both needs, governments produce two types of financial statements: fund financial statements and government-wide financial statements.

Fund-based statements provide financial information about each major fund of a government. As will be discussed more in future chapters, governmental funds use a different measurement focus and basis of accounting (MFBOA) than do proprietary funds and fiduciary funds. Because of this difference, it would not be appropriate to report financial information measured differently in the same financial statements. To do so would be like comparing apples and oranges. As a result, separate fund-based statements are reported for each fund category.

The separate fund financial statements for each fund category are as follows1:

  • Governmental funds
    • Balance sheet
    • Statement of revenues, expenditures, and changes in fund balances (also called “resource flows statements” in GASB Concepts Statement No. 4, Elements of Financial Statements)
  • Proprietary funds
    • Statement of net position or balance sheet
    • Statement of revenues, expenses, and changes in fund net position (also called “resource flows statements” in GASB Concepts Statement No. 4)
    • Statement of cash flows (also called resource flows statements in GASB Concepts Statement No. 4)
  • Fiduciary funds
    • Statement of fiduciary net position
    • Statement of changes in fiduciary net position

Government-wide statements are intended to provide information about the financial resources and activities of the overall government. The statements report information about governmental activities and business-type activities and a total for the primary government. Producing these government-wide statements from the fund-based statements is not as simple as it may seem. Several adjustments must be made to the information in the fund-based statements to produce meaningful government-wide statements. The major adjustments are as follows:

  • Information in the government-wide statements must be reported using the same MFBOA. To accomplish this, governmental funds information must be converted to the same MFBOA used by proprietary funds.
  • The resources and activities of internal service funds are reported with governmental activities if they mainly serve governmental funds. If they mainly serve enterprise funds, they are reported with business-type activities.
  • Certain intragovernmental activities are eliminated.
  • Fiduciary funds are not reported in the government-wide statements.

Fund financial statements must provide a reconciliation to the government-wide statements. The reconciliation provides a summary of the preceding adjustments.

The two government-wide statements2 are

  • statement of net position and
  • statement of activities (also called “resource flows statements” in GASB Concepts Statement No. 4).

Governments are required to report both fund financial statements and government-wide statements in their general-purpose external financial statements. GASB requires that general-purpose financial statements contain the following, at a minimum:

  • Management’s discussion and analysis (MD&A)
  • Basic financial statements
    • Government-wide financial statements
    • Fund financial statements
    • Notes to the financial statements
  • Required supplementary information (other than MD&A)

The relationship of the different elements required for general-purpose financial statements can be seen in the chart that follows. As discussed previously, the fund financial statements and government-wide statements provide different information about the government’s financial resources. The arrow between the two types of statements emphasizes the fact that the two statements must be reconciled. The reconciliation is presented as part of the fund financial statements or in an accompanying schedule.

image

Summary

To meet the financial objective of accountability, governments use funds to report financial resources and activity. Funds are separate accounting entities for which financial statements can be prepared. There are 11 different fund types that fall into three categories: governmental funds, proprietary funds, and fiduciary funds. Governmental funds use a different MFBOA than do proprietary and fiduciary funds.

Financial reporting by governments must include information about individual major funds and fund categories as well as information about the overall government. Therefore, governments report both fund financial statements and government-wide financial statements. Separate fund financial statements are reported for each of the three fund categories. Two government-wide statements are reported for the overall government: the statement of net position and the statement of activities. The fund financial statements must be reconciled to the government-wide financial statements.

Knowledge check

  1. Which statement is accurate regarding the fund financial statements?
    1. There are separate fund financial statements for each fund category.
    2. All funds report a statement of cash flows.
    3. Only fiduciary funds report fund financial statements.
    4. All fund financial statements use the same MFBOA.

Practice questions

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

  1. What is a characteristic of a fund?
    1. Fiscal entity.
    2. Accounting entity.
    3. Contains self-balancing set of accounts.
    4. All the above.
  2. What is a fund category used by governments?
    1. Expendable funds.
    2. Current funds.
    3. Plant funds.
    4. Proprietary funds.
  3. Which is a governmental fund?
    1. Private-purpose trust fund.
    2. Enterprise fund.
    3. Permanent fund.
    4. Internal service fund.
  4. Which is a proprietary fund?
    1. Debt service fund.
    2. Special revenue fund.
    3. Permanent fund.
    4. Enterprise fund.
  5. A statement of revenues, expenditures, and changes in fund balance is required for which?
    1. A proprietary fund.
    2. An internal service fund.
    3. The general fund.
    4. All the above.
  6. A government-wide financial statement includes which?
    1. Statement of revenues and expenses.
    2. Statement of activities.
    3. Statement of cash flows.
    4. Statement of changes in net position.
  7. Which is not a fund financial statement?
    1. Statement of revenues, expenditures, and changes in fund balance.
    2. Statement of cash flows.
    3. Statement of activities.
    4. Statement of changes in fiduciary net position.
  8. Which fund would report a statement of cash flows?
    1. Enterprise fund.
    2. Private-purpose trust fund.
    3. Special revenue fund.
    4. All the above.
  9. A government decides to open a new park and to charge a fee to cover a portion of the cost. Discuss the possible fund types in which this activity may be reported.

     

     

  10. For each of the following individual funds, indicate in the blank space the fund type (for example, a capital projects fund) in which it typically belongs:

    ______ Water and sewer utility fund.

    ______ Endowment fund for purchase of library books.

    ______ City Hall construction fund.

    ______ General long-term bond redemption fund.

    ______ Central print-shop fund.

    ______ Parking deck fund.

    ______ Federal grant fund.

    ______ State grant for new bridge fund.

    ______ High school graduate scholarship fund.

    ______ Fleet center fund.

    ______ Employee retirement fund.

  11. For each of the following individual funds, to which fund category does it belong: governmental (G), proprietary (P), or fiduciary (F)?

    ______ Enterprise fund.

    ______ Permanent fund.

    ______ Debt service fund.

    ______ Investment trust fund.

    ______ General fund.

    ______ Special revenue fund.

    ______ Capital project fund.

    ______ Private-purpose trust fund.

    ______ Internal service fund.

    ______ Pension (and other employee benefit) trust fund.

Notes

  1. 1  Appendix A provides examples of both fund financial statements and government-wide financial statements.
  2. 2  See footnote 1.
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