Governmental funds

Governmental funds use a flow of current financial resources measurement focus. The financial statements measure whether financial resources that can be spent in the near future have increased or decreased for the accounting period.

Inflows of current financial resources are reported as revenues or other financing sources and outflows are reported as expenditures or other financing uses. The net change for the year indicates whether inflows of current financial resources were larger than outflows of such resources.

Another way to describe the measurement basis of accounting is by using the accounting equation. The accounting equation for a governmental fund follows:

Current assets + Deferred outflows of resources = Current liabilities + Deferred inflows of resources + Fund balance

There are three major differences between this accounting equation and that used by a business. The first is that the fund balance represents net financial resources that can be spent in the near future. It does not represent the difference between all the economic assets and liabilities of the organization.

The second major difference between the equations is the exclusion of capital assets. What happens when a capital asset is purchased? Cash and fund balance would both decrease (an expenditure would be recorded). There would be no need to record depreciation because the full cost of the assets would have been recorded as an expenditure when it was purchased.

The third major difference between the equations is the absence of long-term debt. Does this mean that governments do not issue long-term debt for governmental activities? No. When a government issues long-term debt for governmental activities, both cash and fund balance would increase (other financing sources would be recorded). The future repayment of the long-term debt would not need to come from current available financial resources but would be repaid from financial resources generated in the future. When debt is repaid from a governmental fund, cash and fund balance would decrease (an expenditure would be recorded).

Does this mean that capital assets and long-term debt are not reported in the financial statements? It depends. Because the governmental funds’ financial statements are reporting the flow of current financial resources, they would not appear there. However, they would appear in the government-wide financial statements. The government-wide financial statements are reporting all economic resources and liabilities of the government.

Proprietary funds

Proprietary funds use a flow of economic resources measurement focus. The financial statements measure whether the economic resources have increased or decreased for the accounting period. This is the same measurement focus used by business organizations.

Inflows of economic resources are reported as revenues or gains and outflows are reported as expenses or losses. The net change in economic resources for a year is very similar to the net income measurement used in business.

The accounting equation for a proprietary fund follows:

Assets + Deferred outflows of resources − Liabilities – Deferred inflows of resources = Net position

Proprietary funds would account for both current and noncurrent assets and liabilities. For example, capital assets and long-term debt both would be reported as part of these funds.

The following table lists the key differences between governmental and proprietary funds that result from the measurement focus of accounting.

Governmental funds

Governmental funds use the modified accrual basis of accounting. This basis of accounting requires a transaction that affects current financial resources to be measured as a revenue or expenditure. For example, an inflow of current financial resources will be recorded as revenue only if it is received in time to liquidate a current-period liability.

For an item to be measured as revenue it must meet two conditions: it must be measurable and it must be available to meet current obligations. To meet the availability criterion, revenue must be collected during the year or soon enough after year-end to pay liabilities of the current period.

Expenditures are recorded when incurred only if the transaction will require the use of current financial resources. For example, vacation leave earned by an employee will be recognized as an expenditure only to the extent that it will be paid out of current financial resources. There are certain exceptions to the expenditure recognition rule.

Proprietary funds

Proprietary funds use an accrual basis of accounting similar to that used by a business. This basis of accounting records transactions when they occur, regardless of the related cash flow. Revenues are recognized when they are both measurable and earned. Expenses are recorded when incurred. In contrast to the modified accrual basis of accounting, the full amount of vacation leave earned by an employee would be recognized as an expense.

Interfund transactions

There are frequent transactions between different funds of a government. Activities among the funds are classified as either reciprocal interfund activity or nonreciprocal interfund activity.

Reciprocal interfund activity includes loans and services provided and used. Interfund loans should be reported separately in the financial statements as interfund receivables and payables. If repayment of a loan is not expected within a reasonable time, the amount recorded as a loan should be reduced and reported as a transfer.

Interfund services provided and used are treated as an internal exchange-like transaction. Revenue is recorded in the seller fund and expenditures or expenses are recorded in the purchaser fund.

Nonreciprocal interfund activity includes transfers and reimbursements. Interfund transfers represent a flow of assets from one fund to another that will not be repaid. In governmental funds, these transfers are reported as “other financing sources” (by the fund receiving the transfer) or “other financing uses” (by the fund making the transfer). Proprietary funds would report transfers after nonoperating revenues and expenses on the statement of revenues, expenses, and changes in fund net position.

Interfund reimbursements represent the repayment for a particular expenditure or expense by a fund responsible for the charge to the fund that initially paid for the item. The net effect of a reimbursement is that the expense or expenditure in one fund would be reduced; the expense or expenditure in another fund would be increased.

Special items and extraordinary items

Governments separately report transactions or events that meet the definition of special items and extraordinary items. These items are reported at the bottom of the fund financial operating statements for governmental and proprietary funds and at the bottom of the government-wide statement of activities.

A special item is a significant transaction or event within the control of management that is either unusual in nature or infrequent in occurrence.

An extraordinary item is a transaction or event that is both unusual in nature and infrequent in occurrence.

Deferred outflows of resources and deferred inflows of resources

GASB Statement No. 65, Items Previously Reported as Assets and Liabilities, lists several specific items that should now be reported as either deferred outflows of resources or deferred inflows of resources. In addition, GASB Statement No. 53, Accounting and Financial Reporting for Derivative Instruments; GASB Statement No. 60, Accounting and Financial Reporting for Service Concession Arrangements; GASB Statement No. 68, Accounting and Financial Reporting for Pensions — An Amendment of GASB Statement No. 27; GASB Statement No. 69, Government Combinations and Disposals of Government Operations; GASB Statement No. 73, Accounting and Financial Reporting for Pensions and Related Assets That Are Not Within the Scope of GASB Statement 68, and Amendments to Certain Provisions of GASB Statements 67 and 68; GASB Statement No. 75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions; GASB Statement No. 81, Irrevocable Split-Interest Agreements; GASB Statement No. 83, Certain Asset Retirement Obligations; and GASB Statement No. 87, Leases, also identified items that should be reported as deferred outflows of resources or deferred inflows of resources.

A deferred outflow of resources is a consumption of net assets by the government that is applicable to a future reporting period. The following is a list of items that the GASB has identified that should be reported as deferred outflows of resources:

• Grant paid in advance of meeting timing requirement
• Deferred amounts from refunding of debt (debits)
• Cost to acquire rights to future revenues (intra-entity)
• Deferred loss from sale-leaseback
• Certain items related to pensions under GASB Statement No. 68
• Certain Items related to postemployment benefits other than pensions under GASB Statement No. 75
• Asset retirement obligation

A deferred inflow of resources is an acquisition of net assets by the government that is applicable to a future reporting period. The following is a list of items that GASB has identified that should be reported as deferred inflows of resources:

• Grants received in advance of meeting timing requirement
• Deferred amounts from refunding of debt (credits)
• Proceeds from sales of future revenues
• Deferred gain from sale-leaseback
• “Regulatory” credits
• Certain items related to pensions under GASB Statement No. 68
• Certain items related to postemployment benefits other than pensions under GASB Statement No. 75
• Net resources received pursuant to an irrevocable split-interest agreement
• The value of a lease receivable plus any payments received at or before the commencement of a lease term that relate to future periods by the lessor for the inception of a lease under GASB Statement No. 87

Governmental funds recognize revenue when it is measurable and available. When an asset is recorded in a governmental fund but the revenue is not available, a deferred inflow of resources should be reported.

Transactions reported by governmental funds

Governmental funds report certain transactions in a separate section of the statement of revenues, expenditures, and changes in fund balances; this section is called “Other financing sources and uses.” These transactions either provide or use financial resources but are not considered revenues or expenditures.

Other financing sources and uses include the face value of debt issued, issuance premiums or discounts, certain payments to escrow agents for bond refundings, transfers, some insurance proceeds, and sales of capital assets (unless the sale meets the criteria to be reported as a special item).

Only items identified in the preceding paragraph can be reported as other financing sources and uses.

Fund balance

Governmental funds use the term fund balance to represent the difference between current financial assets and current financial liabilities. Under GASB Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, governments have five classifications.

Under GASB Statement No. 54, governmental fund balances should be reported in classifications arranged in a hierarchy. This hierarchy is built primarily on the extent to which a government is bound to honor constraints on the specific purposes for which amounts in those funds can be spent.

GASB Statement No. 54 allows some flexibility in the level of detail presented. For example, the two components of nonspendable fund balances (not in spendable form and legally or contractually required to be maintained intact) may be presented separately or in the aggregate. However, if a nonspendable fund balance is displayed in the aggregate on the face of the balance sheet, amounts for the two nonspendable components should be disclosed in the notes to the financial statements.

GASB Statement No. 54 has several disclosure requirements. For example, governments should disclose the following about their fund balance classification policies and procedures:

	For committed fund balance: (1) the government’s highest level of decision-making authority and (2) the formal action that is required to be taken to establish (and modify or rescind) a fund balance commitment
	For assigned fund balance: (1) the body or official authorized to assign amounts to a specific purpose and (2) the policy established by the governing body pursuant to which that authorization is given.
	For the classification of fund balances in accordance with paragraph 18 of GASB Statement No. 54: (1) whether the government considers restricted or unrestricted amounts to have been spent when an expenditure is incurred for purposes for which both restricted and unrestricted fund balance is available; and (2) whether committed, assigned, or unassigned amounts are considered to have been spent when an expenditure is incurred for purposes for which amounts in any of those unrestricted fund balance classifications could be used

Net position

The term net position is used to represent the difference between assets (+ deferred outflows of resources) and liabilities (+ deferred inflows of resources) for proprietary funds and in the government-wide statements. Net position is divided into the following three components:

1. The net investment in capital assets component of net position consists of capital assets and net of accumulated depreciation, reduced by the outstanding balances of bonds, mortgages, notes, or other borrowings that are attributable to the acquisition, construction, or improvement of those assets. Deferred outflows of resources and deferred inflows of resources that are attributable to the acquisition, construction, or improvement of those assets or related debt should also be included in this component of net position. If there are significant unspent related debt proceeds or deferred inflows of resources at the end of the reporting period, the portion of the debt or deferred inflows of resources attributable to the unspent amount should not be included in the calculation of net investment in capital assets. Instead, that portion of the debt or deferred inflows of resources should be included in the same net position component (restricted or unrestricted) as the unspent amount.
2. The restricted component of net position consists of restricted assets reduced by liabilities and deferred inflows of resources related to those assets. Generally, a liability relates to restricted assets if the assets result from a resource flow that also results in the recognition of a liability or if the liability will be liquidated with the restricted assets reported. Constraints can be either externally imposed (for example, debt covenants or grantor restrictions) or imposed by constitutional provisions or enabling legislation¹.
3. The unrestricted component of net position is the net amount of the assets, deferred outflows of resources, liabilities, and deferred inflows of resources that are not included in the determination of net investment in capital assets or the restricted component of net position. Unlike fund balance, designations of unrestricted net assets should not be reported on the face of the financial statements.