CHAPTER 20

NONEXCHANGE TRANSACTIONS

Classes of Nonexchange Transactions

Accounting and Financial Reporting Requirements

Accrual-basis requirements

Modified accrual basis

Property Taxes

Income and Sales Taxes, and Other Derived Tax Revenues

Adjustments for the Accrual Basis of Accounting

Grants and Other Financial Assistance

What financial assistance should be recorded?

Revenue recognition of grants and other financial assistance

Expenditure-driven grants and other financial assistance revenue

Practice Issues

The term nonexchange transaction has only recently gained wide use in government accounting and financial reporting, so governmental financial statement preparers may at first think that this chapter will not have broad applicability.

However, once it is understood that taxes are nonexchange transactions, it becomes clear that nonexchange transactions include accounting and financial reporting requirements for a significant part of a governmental entity’s typical transactions.

GASB Statement 33, Accounting and Financial Reporting for Nonexchange Transactions (GASBS 33), divides all transactions into two categories.

As will be more fully described below, nonexchange transactions therefore include very significant items of revenues and expenditures for governmental activities, such as taxes (including property, sales, and income taxes) as well as revenues provided by federal and state aid programs.

Classes of Nonexchange Transactions

GASBS 33 identifies four classes of nonexchange transactions.

Accounting and Financial Reporting Requirements

GASBS 33 has different accounting standards for revenue recognition under the accrual basis of accounting and the modified accrual basis of accounting. Under either basis of accounting, recognition of nonexchange transactions in the financial statements is required unless the transactions are not measurable (reasonably estimable) or are not probable (likely to occur) of collection. Transactions that are not recognized because they are not measurable should be disclosed.

Accrual-basis requirements

In using the guidance of GASBS 33 for nonexchange transactions that are accounted for under the accrual basis of accounting, it is important to note that these are different standards for time requirements and purpose restrictions in determining whether a transaction has occurred.

• Time requirements—When a nonexchange transaction is government-mandated or voluntary, compliance with time requirements is necessary for the transaction to occur. Time requirements must be met for a provider to record a liability or expense and for a recipient to record a revenue and a receivable. For imposed nonexchange transactions, a government should recognize a receivable when it has an enforceable legal claim to the resources, but should not recognize revenue until the period when the use of the resources is required or first permitted.
• Purpose restrictions govern what a recipient is allowed to do with the resources once it receives them. Recognition of assets, liabilities, revenues, and expenses should not be delayed because of purpose restrictions. An exception arises in a grant or agreement in which the resource provider will not provide resources unless the recipient has incurred allowable expenditures under the grant or agreement. This is an eligibility requirement. In that case, there is no reward (i.e., no asset, liability, revenue, or expense) recognition until the recipient expends the resources. (This exception relates to what was once referred to as expenditure-driven revenue.) Cash or other assets provided in advance should be reported as advances by providers and as deferred revenues by recipients.

In addition to these general requirements for the accrual basis of accounting, GASBS 33 provides specific guidance for each class of nonexchange transaction.

• Derived tax revenues—Assets from derived tax revenues are recognized as revenue in the period when the exchange transaction on which the tax is imposed occurs or when the resources are received, whichever occurs first. Resources received by a government in anticipation of an assessable exchange transaction should be reported as deferred revenue until the period of the exchange.
• Imposed nonexchange revenues—Assets from imposed nonexchange revenue transactions are to be recognized in the period when an enforceable legal claim to the assets arises or when the resources are received, whichever occurs first. For property taxes, this is generally (but not always) the date when the government has a right to place a lien on the property (the lien date).

• Government-mandated nonexchange transactions and voluntary nonexchange transactions—GASBS 33 provides that a transaction for these two classes of transactions does not occur (other than the provision of cash in advance) and should not be recognized until all eligibility requirements are met. In other words, the provider has not incurred a liability and the recipient does not have a receivable, and recognition of revenues and expenses for resources received or provided in advance should be deferred.

The GASB issued GASB Statement 36, Recipient Reporting for Certain Shared Nonexchange Revenues—An Amendment of GASB Statement 33 (GASBS 36), to provide a technical correction of a requirement contained in GASBS 33. There are a number of circumstances in which a government may share its revenues with another government. Under GASBS 33 as originally issued, a resource-providing government and a recipient government may have recognized these revenues at different times. GASBS 36 supercedes paragraph 28 of GASBS 33 to eliminate this potential discrepancy. Both the resource-providing government and the recipient government should comply with the requirements of GASBS 33, as amended, for voluntary or government-mandated nonexchange transactions, as appropriate. Because some recipient governments receive these shared revenues through a continuing appropriation, they may rely on periodic notification by the provider government of the accrual-basis information necessary for compliance. If the resource-providing government does not notify the recipient government in a timely manner, the recipient government should use a reasonable estimate of the amount to be accrued. In this instance before amendment, GASBS 33 would have called upon the recipient government to record these revenues on a basis of cash collections instead of using an estimate.

The eligibility requirements are specified by GASBS 33 to comprise one or more of the following:

Recipients should recognize assets and revenues from government-mandated or voluntary nonexchange transactions when all applicable eligibility requirements are met. If private donations to a government meet the above criteria, including promises to give, they should be recognized in the financial statements of the government.

Modified accrual basis

The preceding discussion describes the proposed transaction recognition criteria using the accrual basis of accounting. GASBS 33 also addresses revenue recognition using the modified accrual basis of accounting. Revenues from nonexchange transactions should be recognized in the accounting period when they become measurable and available. While this is consistent with current practice (except for the elimination of the “due date” criteria under GASBI 5, Property Tax Revenue Recognition in Governmental Funds), GASBS 33 provides the following guidance for each of the four classes of nonexchange transactions:

Some examples of how some of the more common resources of governments would be recorded follow.

Property Taxes

Property taxes represent a significant source of revenue for many governments, particularly local governments. These governments, therefore, must make sure that they apply governmental accounting principles appropriately in reporting property tax revenues.

Property taxes recorded in a governmental fund should be accounted for as an imposed nonexchange revenue using the modified accrual basis. When a property tax assessment is made, it is to finance the budget of a particular period, meaning that the property taxes are intended to provide funds for the expenditures of that particular budget period. The revenue produced from any property tax assessment should be recognized in the fiscal period for which it is levied, provided that the “available” criterion of the modified accrual basis of accounting is met. (Available means that the property taxes are due to the government or past due and receivable within the current period, and are collected within the current period or expected to be collected soon enough thereafter to be used to pay current liabilities.) Property taxes that are due or past due must be collected within sixty days after the period for which they were levied. For example, if property taxes are levied for a fiscal year that ends on June 30, 20X1, property taxes that were assessed and due for this period (and prior periods) can be recognized as revenue as long as they are collected by August 29, 20X1.

If unusual circumstances justify a period of greater than sixty days, the government should disclose the length of the period and the circumstances that justify its use. For example, in unusual circumstances, a government may be able to demonstrate that property taxes received after sixty days would be available to pay current liabilities if the current liabilities will be paid sometime after sixty days after year-end. Thus, there are two criteria that must be met before property tax revenue is to be recognized.

The GASB issued Interpretation 5, Property Tax Revenue Recognition in Governmental Funds (GASBI 5), which eliminated the former criteria that the property taxes must be due or past due within the reported period in order to be recognized.

In recording property taxes, there is a difference as to when a receivable is recorded for property tax revenue and when the related revenue is recognized. A receivable should be recorded on the balance sheet for property tax receivables (net of estimated uncollectible property taxes receivable) on the date that the property taxes are levied. To the extent that property taxes receivable exceed the amount of revenue that may be recognized under the “available” criterion, the difference should be recorded as deferred revenue. Accordingly, revenue should only be recognized for the amount of the property taxes receivable amount on the balance sheet at the end of the fiscal year for the amounts of the property tax receivable that were collected sixty days after the balance sheet date. The difference between the property tax receivable at the fiscal year-end and the amount recognized as property tax revenue should be recorded as deferred property tax revenue.

In addition, when property taxes are collected in advance of the year for which they are levied, the advance collections should be recorded as deferred revenue. These advance collections should not be recognized as revenue until the period for which they were levied is reached.

Some representative journal entries should clarify the accounting for property tax revenues.

The sequence of these journal entries may change, based on the operating procedures of the government. For example, the government may record all collections of property tax revenue as deferred revenue and then recognize the proper amount of property tax revenue at year-end, and then again when the sixty-day subsequent period collections are determined. The sequence of the journal entries is not as important as the government recognizing only the appropriate amount of property tax revenue and recording the proper amount of property taxes receivable and deferred property tax revenues.

In addition to recording the transactions described above properly, the government should also periodically review the propriety of the allowance for uncollectible real estate taxes and consider writing off against the allowance for those taxes from specific taxpayers that are not likely to be collected. The government should also determine whether the allowance for uncollectible taxes is understated.

This is unique to the modified accrual basis of accounting for property taxes, because increasing an allowance for an uncollectible receivable has no impact on the operating statement of the entity. It is strictly a journal entry affecting two balance sheet accounts.

Unless they must be used to support a specific program, property taxes are reported as general revenues on the government-wide statement of activities. Converting the property tax revenue recorded in the governmental funds on a modified accrual basis to the accrual basis for purposes of accounting for the government-wide statements is fairly easy. Conceptually, the difference in the revenue between the two bases of accounting is the amount that was deferred as not collected within sixty days under the modified accrual method. Basically, the government would reverse entry 3 listed above as follows for the government-wide statements:

The difference in the actual amount of revenue recognized under the two different accounting bases, however, will not actually be $9,000 in this example, because similar entries would have been recorded in the prior year to set up deferred revenue on the modified accrual basis and then reverse it for the government-wide statements. The actual effect on the revenue recognized between the two methods would be the difference in the amounts deferred under the modified accrual basis from one year to the next, since the prior year entry would have been reversed.

Income and Sales Taxes, and Other Derived Tax Revenues

Income taxes usually represent a significant source of revenue to governments. Sales taxes are another common form of significant revenue provider that is used by governments to fund operations. In addition, other forms of derived taxes, such as cigarette taxes, provide revenues to many state and local governments. What these taxes have in common is that they are derived from taxes imposed on exchange transactions.

On a modified accrual basis, the revenue from these taxes is fairly easy to determine because the availability criteria focus governments’ attention on the collections from these taxes shortly after year-end. In practice, many governments have been using a one-month or two-month collection period after year-end (depending on the nature of the tax and how and when tax returns are filed) to determine the amounts that are recorded on the modified accrual basis. On the accrual basis, revenue recognition becomes more complicated in that estimates of what will be ultimately received for taxes imposed on exchange transactions occurring during the governments’ fiscal year are required. Since many governments do not have fiscal years that match the calendar year and since many of these taxes are based on calendar-year tax returns, the calculations are further complicated.

Taxpayer-assessed revenues are difficult to measure for a number of reasons. First, the reporting period for these revenues is often a calendar year, and the majority of governments have a fiscal year that is other than the calendar year, and accordingly there are overlapping reporting periods. Second, the tax returns or remittance forms taxpayers use to remit these taxes are usually not due until several months after the calendar year-end and are subject to extension requests. Third, these types of taxes, particularly income taxes, are subject to estimated payment requirements throughout the year, and the final amount of the tax is determined when the tax return form is actually completed. Finally, since the revenues are taxpayer-assessed, it is sometimes difficult for the government to satisfactorily estimate the amount of tax it will ultimately receive based on historical information, because the taxes are generally based on the relative strength of the economy during the calendar year reported by the taxpayer. Historical information does not always have a direct correlation with the current status of the economy.

In some cases taxpayer-assessed revenues are collected by a level of government different from the government that is the actual beneficiary of the tax. For example, a state may be responsible for collecting sales taxes, although portions of the sales taxes collected are actually revenues of counties or cities located within the state. In these cases, the state will remit sales tax collections to the local governments (counties, cities, etc.) periodically. Similar situations exist where states collect personal income taxes imposed by major cities within the state.

The local governments receiving taxes collected by another level of government should apply the same criteria of recognizing these revenues (i.e., when they are measurable and available). If the collecting government remits the local government’s portion of the taxes promptly, the local government is likely to recognize revenue in similar amounts to that which they would recognize if they collected the revenues themselves. On the other hand, if the collecting government imposes a significant delay until the time that it remits the portion of the collections due the local government to that local government, consideration must be given to when these revenues actually become available to the local government, given their delay in receiving the revenues from the collecting government.

In addition to accruing revenues for taxpayer-assessed taxes, governments must make the appropriate liability accruals for refunds that they are required to make based on tax returns that are filed. Governments should use actual refunds made after the fiscal year-end, combined with estimates for refunds made using a combination of historical experience and information about the economy of the fiscal year reported. When a government records this liability accrual, it should record the accrual as a reduction of the related tax revenue presented in the general or special revenue fund and as a liability of the fund. The liability should be recorded in the fund through a reduction of the related revenue rather than simply recording a refund liability in the general long-term debt account group. Tax refunds are likely to be a liability to be liquidated with current financial resources, and accordingly, a fund liability rather than a general long-term debt account group liability, is recorded. Netting the tax refunds with the related tax revenues also provides a more accurate picture of the amount of tax revenues that should actually have been recorded by the government.

Adjustments for the Accrual Basis of Accounting

In order to report the derived revenues from the taxes described in the previous paragraphs on the accrual basis of accounting and economic resources measurement focus, the government needs to consider the taxes that will be collected after the availability period that is used for reporting these revenues on a modified accrual basis. The government needs to calculate how much revenue it “earns” during its fiscal year from exchange transactions that occurred during that fiscal year from exchange transactions that occurred during that fiscal year.

Consider the following example: A taxpayer prepares an income tax return for the calendar year ended December 31, 20X1. The taxpayer had withholdings taken from her salary during the year. In addition, the taxpayer made estimated tax payments throughout the year, with the final estimated payment made on January 15, 20X2. The taxpayer filed an extension request on April 15, 20X2, and paid an amount she estimated would be due with the final return. The return was filed on August 15, 20X2, which resulted in a refund that the taxpayer applied to her estimated payments for the calendar year ending December 31, 20X2. When completing her 20X2 tax return, the taxpayer discovers an error in the 20X1 return and files an amended return on May 15, 20X3, requesting an additional refund. How much would the government ultimately be entitled to receive in taxes from the earnings of the taxpayer during the government’s fiscal year ended June 30, 20X1?

To approximate the answer to this question, a government would need to look at each component of the various tax events that are described above and determine how best to record the revenues (or refund) that occur from those events. The government has to assume that it is virtually impossible for it to have actual information in time for it to prepare its own financial statements on a timely basis. Furthermore, the fact that the tax year and the government’s fiscal year are different essentially assures that some estimation process is required.

Each government’s tax procedures and requirements are different, and different taxes work in different ways, so there is no set of prescribed procedures that can be suggested that will result in the best method in every case. Nevertheless, there are some general processes and procedures that might prove helpful. In the example described above, the government would probably be best off breaking the various tax events into groups and handling each in the most practical way. For example, withholding taxes are based on salary earnings and usually must be remitted to governments in a very short period of time. Perhaps withholding taxes received during the year should be recognized by the government in the year received. Similarly, estimated tax payments are often received quarterly and should correspond with estimates of earnings for each particular quarter. The estimated tax receipts related to the four quarters that comprise the government’s fiscal year might be assumed to be recorded within that fiscal year. Tax payments received with returns and refunds made with returns filed on a timely basis (or received with extension request) might be aggregated and assumed to occur ratably over the calendar year. Accordingly, of the amounts received (or refunded) for calendar year 20X0, the government might assume that half were received in its 20X0 fiscal year and half in its 20X1 fiscal year. Projection of the first half of 20X2 would be needed and could be based on past history and adjusted for known factors, such as changes in tax rates or rising or declining incomes. Further, the government might determine that the amounts received or paid with amended returns is very small and may choose to simply account for these in the same period received or paid.

Note that not all derived tax revenues will be this difficult to calculate. For example, many governments require that sales taxes be remitted on a monthly basis. It should be fairly easy to match the receipts of sales tax revenues to the months of the fiscal year to which those taxes relate. For example, for a June 30 year-end, if sales taxes relating to the month of June are due to be remitted by July 20, the government would accrue the July receipts back to June, since that is when the sales on which the sales tax revenues were derived occurred.

Grants and Other Financial Assistance

State and local governments typically receive a variety of grants and other financial assistance. At the state level, this financial assistance may be primarily federal financial assistance. At the local government level, the financial assistance may be federal, state, or other intermediate level of local government. Financial assistance generally is legally structured as a grant, contract, or cooperative agreement. The financial assistance might take the form of entitlements, shared revenues, pass-through grants, food stamps, and on-behalf payments for fringe benefits and salary.

What financial assistance should be recorded?

Governments often receive grants and other financial assistance that they are to transfer to or spend on behalf of a secondary recipient of the financial assistance. These agreements are known as pass-through grants. All cash pass-through grants should be reported in the financial statements of the primary recipient government and should be recorded as revenues and expenditures of that government.

There may be some infrequent cases when a recipient government acts only as a cash conduit for financial assistance. Guidance on identifying these cases is provided by GASB Statement 24 (GASBS 24), Accounting and Financial Reporting for Certain Grants and Other Financial Assistance. In these cases, the receipt and disbursement of the financial assistance should be reported as transactions of an agency fund. A recipient government serves as a cash conduit if it merely transmits grantor-supplied money without having administrative or direct financial involvement in the program. Some examples of a recipient government that would be considered to have administrative involvement in a program are provided by GASBS 24, as follows:

• The government monitors secondary recipients for compliance with program-specific requirements.
• The government determines eligibility of secondary recipients or projects, even if grantor-supplied criteria are used.
• The government has the ability to exercise discretion in how the funds are allocated.

A recipient government has direct financial involvement if, as an example, it finances some direct program costs because of grantor-imposed matching requirements or is liable for disallowed costs.

Revenue recognition of grants and other financial assistance

Grants, entitlements, or shared revenues recorded in the general and special revenue funds should be recognized as revenue in the accounting period in which they become susceptible to accrual (they are measurable and available). In applying these criteria, the financial statement preparer must consider the legal and contractual requirements of the particular financial assistance being considered.

Financial assistance in the form of shared revenues and entitlements is often restricted by law or contract more in form than in substance. Only a failure on the part of the recipient to comply with prescribed regulations would cause a forfeiture of the resources. Such resources should be recorded as revenue at the time of receipt, or earlier if the susceptibility to accrual criteria are satisfied. If entitlements and shared revenues are collected in advance of the period that they are intended to finance, they should be recorded as deferred revenue.

Grants are nonexchange transactions that would be classified as either government-mandated or voluntary nonexchange transactions. The accounting for both of these transactions is similar and is described earlier in this chapter. Many of the government-mandated grants that are received by governments are expenditure driven. These are covered later in this section. In many of the remaining grants, the key accounting component is when eligibility requirements are met, which determine when it is appropriate for the recipient government to recognize the grant as revenue. If the actual cash is received before the eligibility requirements have been met, the cash should be recorded as a deferred revenue until the eligibility requirements are met. On the other hand, if the eligibility requirements have been met and the cash has not yet been received by the recipient government, the recipient government would record a receivable and revenue for the grant revenue that it is owed. For recording this amount in a governmental fund on the modified accrual basis of accounting, the availability criteria should be examined to see if the revenue should be recognized or recorded as deferred revenue. In practice, grant revenue is usually received within a timeframe where the availability criteria are met (this is also discussed later, in the expenditure-driven revenue section).

One of the more important eligibility requirements is the time requirement, where the time period in which a grant is to be spent is specified. For example, if a state government provides formula-based education aid to a local government or a school district and specifies that the aid is for the school year that begins in September and ends in June, that is the period of time for which the grant revenue would be recognized. Few, if any, differences between the modified accrual basis of accounting on the fund level and the accrual basis of accounting at the government-wide level should arise. However, if no time period is specified (and all other eligibility requirements are met) the total amount of the grant would be recognized as revenue immediately. For example, assume that a state government with a December 31 year-end provides a grant to a local government in its budget for its fiscal year which begins on January 1, 20X1. The local government has a fiscal year of June 30. If there are no time requirements and all other eligibility criteria are met, the grant appropriation at the state level is available on January 1, 20X1, the first day of the state’s fiscal year. In this case, the local government would recognize the revenue from the whole grant on January 1, 20X1.

Expenditure-driven grants and other financial assistance revenue

Many grants and other financial aid programs are on a cost-reimbursement basis, whereby the recipient government “earns” the grant revenue when it actually makes the expenditures called for under the grant. This type of arrangement is described as “expenditure-driven” revenue, since the amount of revenue that should be recognized is directly related to the amount of expenditures incurred for allowable purposes under the grant or other contractual agreement. (Of course, the amount of revenue recognized under a grant or contract should not exceed the total allowable revenue for the period being reported, regardless of the amount of expenditures.) Updating the terminology for GASBS 33, making the expenditure is simply an eligibility requirement. To be eligible for the grant revenue, you must make the expenditure. The accounting for most expenditure-driven grants is likely to remain the same under GASBS 33 as it was prior to adoption of GASBS 33.

In accounting for expenditure-driven revenue, governments typically make the expenditures first and then claim reimbursement from the grantor or other aid provider. In this case, a receivable should be established, provided that the criteria for recording revenue under the modified accrual basis of accounting are satisfied. For expenditure-driven revenues, determining whether the “available” criterion is met is difficult for some grants and other sources of aid. First, there will be a time lag from when the government actually makes the expenditures under the grant, accumulates the expenditure information to conform with some predetermined billing period, and submits the claim for reimbursement to the grantor or other aid provider. Sometimes the grantors and other aid providers delay disbursing payments to the recipient organizations while they review the reimbursement claims submitted by the recipient organization. In some cases, the aid providers even perform some limited types of audit procedures on claims for reimbursement. Often, the actual receipt of cash for expenditure-driven revenues exceeds the period normally considered “available” to pay current obligations. Governments, however, do record the receivable from the grantor or other aid provider and the related grant revenue, despite it being unclear as to whether the “available” criterion will be met. The reason for not requiring that the available criteria be met is that the government has already recognized the expenditures for these grants and other aid programs. Without recognizing the related grant revenue, the governmental fund’s operating statements will indicate that there was a use of resources for these grants and other programs, when in fact, these programs are designed to break even and result in no drain of financial resources on the government. As additional guidance, the GAAFR indicates that in practice, it is uncommon for the recognition of revenue related to reimbursement grants to be deferred based on the availability criterion of modified accrual accounting. Nevertheless, deferral ought to be considered in situations where reimbursement is not expected within a reasonable period. Financial statement preparers and auditors should consider this guidance on current practice in accounting for expenditure-driven revenue.

NCGA Statement 2 provides that when expenditure is the prime factor for determining eligibility for reimbursement, revenue should be recognized when the expenditure is made.

Practice Issues

The first practice issue that a governmental financial statement preparer accounting for nonexchange revenues in governmental fund types will encounter (as with the financial reporting model discussed next) is that information will need to be developed on two bases of accounting—accrual and modified accrual for the government-wide and fund financial statements, respectively. This will clearly result in the modification or enhancement of financial systems to be able to capture revenue information on an accrual basis.

The second practice issue relates to ensuring that, when applicable, the eligibility requirements are met before revenue is recognized in the financial statements. In addition, the timing requirements may also need careful consideration, including where a resource provider does not specify a time requirement, and one needs to be implied using the guidance of the Statement.

Governments that have evaluated the impact of GASBS 33 are finding that its greatest impact is in the area of governmental grants. Applying GASBS 33 tends to result in recording receipts from certain grants as revenue rather than as deferred revenue under prior accounting practice.