(Solution Manual) Government and Not-for-Profit Accounting Concepts and Practices

Granof, Khumawala, Calabrese, Smith, 8

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Author(s): Granof, Khumawala, Calabrese, Smith

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Solutions Manual for Government and Not - for-Profit Accounting Concepts and Practices, 8e Michael Granof, Saleha Khumawala, Thad Calabrese, Daniel Smith (All Chapters ) 1-1 Chapter 1 The Government and Not -For-Profit Environment Questions for Review and Discussion 1. The critical distinction between for -profit businesses and not -for-profits including governments is that businesses have profit as their main motive whereas the others have service. A primary purpose of financial reporting is to report on an entity’s accomplishments — how well it achieved its objectives. Accordingly, the financial statements of businesses measure profitability, their key objective. Financial repo rts of governments and other not -for-profits should not focus on profitability, since it is not a relevant objective. Ideally, therefore, they should focus on other performance objectives, such as how well the organizations met their service goals. In real ity, however, the goal of reporting on how well they have achieved such goals has proven difficult to attain and the financial reports have focused mainly on financially -related data. 2. Governments and not -for-profits are “governed” by the budget, wherea s businesses are governed by the marketplace. The budget is the key political and fiscal document of governments and not -for-profits. It determines how an entity obtains its resources and how it allocates them. It encapsulates most key decisions of consequ ence made by the organization. In a government the budget is not merely a managerial document; it is the law. 3. Owing to the significance of the budget, constituents want assurance that the entity achieves its revenue estimates and complies with its spend ing mandates. They expect the financial statements to report on how the budget was administered. 4. Interperiod equity is the concept that taxpayers of today pay for the services that they receive and not shift the payment burden to taxpayers of the future . Financial reporting must indicate the extent to which interperiod equity has been achieved. Therefore, it must determine and report upon the economic costs of the services performed (not merely the cash costs) and of the taxpayers’ contribution toward covering those costs. 5. The matching concept may be less relevant for governments and not -for-profits than for businesses because there may be no connection between revenues generated and the quantity, quality or cost of services performed. An increase in t he demand for, or cost of, services provided by a homeless shelter would not necessarily result in an increase in the amount of donations that it receives. Of course, governments and not-for-profits are concerned with measuring interperiod equity and for t hat purpose the matching concept may be very relevant. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-2 6. Governments must maintain an accounting system that assures that restricted resources are not inadvertently expended for inappropriate purposes. Moreover, statement users may need separate informati on on the restricted resources by category of restriction and the unrestricted resources. In practice, these requirements have led governments to adopt a system of “fund” accounting and reporting. 7. Even governments within the same category may engage in different types of activities. For example, some cities operate a school system whereas others do not. Those that are not within the same category may have relatively little in common. For example, a state government shares few characteristics with a city. 8. If a government has the power to tax, then it has command over, and access to, resources. Therefore, its fiscal well -being cannot be assessed merely by measuring the assets that it “owns.” For example, the fiscal condition of a city should incorporate the wealth of the residents and businesses within the city, their earning capacity, and the city’s willingness to exploit its tax base. 9. Many governments budget on a cash or near -cash basis. However, the cash basis of accounting does not provide adequate information with which to assess interperiod equity. Financial statements that satisfy the objective of reporting on interperiod equity may not satisfy that of reporting on budgetary compliance . Moreover, statements that report on either interperiod equit y or budgetary compliance are unlikely to provide sufficient information with which to assess service efforts and accomplishments . 10. Measures of service efforts and accomplishments are more significant in governments and not -for-profits because their obj ectives are to provide service. By contrast, the objective of businesses is to earn a profit. Therefore, businesses can report on their accomplishments by reporting on their profitability. Governments and not -for-profits must report on other measures of ac complishment. 11. The FASB influences generally accepted accounting principles of governments in two key ways. First, FASB pronouncements are included in the GASB “hierarchy” of GAAP. FASB pronouncements that the GASB has specifically made applicable to go vernments are included in the highest category; those that the GASB has not specifically adopted are included in the lowest category. Second, the business -type activities of governments are required (with a few exceptions) to follow the business accounting principles as set forth by the FASB. 12. It is more difficult to distinguish between internal and external users in governments than in businesses because constituents, such as taxpayers, may play significant roles in establishing policies that are often considered within the realm of managers. Also, legislators are internal to the extent they set policy, but external insofar as the executive branch must account to the legislative branch. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-3 Exercises EX 1 -1 1. a 2. c 3. c 4. c 5. b 6. c 7. d 8. c 9. b 10. c EX 1 -2 1. b 2. b 3. d 4. b 5. a 6. c 7. a 8. b 9. a 10. b EX 1 -3 a. 1. The Governmental Accounting Standards Board (GASB) is the independent organization that establishes and improves standards of accounting and financial reporting for U.S. state and local governments. Established in 1984 by agreement of the Financ ial Accounting Foundation (FAF) and 10 national associations of state and local government officials, the GASB is recognized by governments, the accounting industry, and the capital markets as the official source of generally accepted accounting principles (GAAP) for state and local governments. Accounting and financial reporting standards designed for the government environment are essential because governments are fundamentally different from for -profit businesses. Furthermore, the information needs of t he users of government financial statements are different from the needs of the users of private company financial statements. The GASB members and staff understand the unique characteristics of governments and the Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-4 environment in which they operate. The G ASB is not a government entity; instead, it is an operating component of the FAF, which is a private sector not -for-profit entity. Funding for the GASB comes primarily from an accounting support fee established under the Dodd -Frank Wall Street Reform and C onsumer Protection Act as well as the sale of certain publications. Its standards are not federal laws or regulations and the organization does not have enforcement authority. Compliance with GASB’s standards, however, is enforced through the laws of some individual states and through the audit process, when auditors render opinions on the fairness of financial statement presentations in conformity with GAAP. 2. The mission of GASB is: To establish and improve standards of state and local governmental accoun ting and financial reporting that will: • Result in useful information for users of financial reports, and • Guide and educate the public, including issuers, auditors, and users of those financial reports. The mission is accomplished through a comprehensive and independent process that encourages broad participation, objectively considers all stakeholder views, and is subject to oversight by the Financial Accounting Foundation’s Board of Trustees. 3. Based on GASB’s White Paper, Governmental Accounting and Fin ancial Reporting is and Should be Different, due t o the key environmental differences between governments and for -profit business enterprises. The differing needs of the users of governmental and business enterprise financial reports reflect the different environments in which the organizations operate. Some of the principal environmental differences are: Organizational Purposes . The purpose of the government is to enhance or maintain the well-being of citizens by providing public services according to the established goals. A government’s financial reports should give creditors, legislative and oversight officials, citizens, and other stakeholders the information necessary to make assessments and decisions relevant to their interests in the government’ s accomplishment of its objectives. In contrast, business enterprises focus on wealth creation, interacting only with those segments of society that fulfill their mission of generating a financial return on investment for shareholders. It's primary focus of reporting has been on earnings and its components, with little or no explicit focus on nonfinancial measures of performance. Sources of Revenue. The principal source of revenue for government is taxation, which is a legally mandated involuntary trans action between individual citizens and businesses and their government. The principal source of revenue of business enterprises is voluntary exchange transactions between willing buyers and sellers. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-5 Potential for Longevity Because of their ongoing power to tax and because of the ongoing need for public services, governments rarely liquidate. The possibility of achieving longevity, however, is not as likely for business enterprises. Business enterprises will go out of existence if, for an extended period o f time, they are unable to sell their products or services for more than it costs to produce them. Further, a business may also cease to exist if it is acquired by another entity . Relationship with Stakeholders . The governments should meet a standard of accountability, since the citizens are interested in evaluating inter -period equity by determining whether current taxpayers and users of government services fully financed the costs of providing current -period services or whether taxes and user fees from p rior or future periods were, or will be, needed to finance the current services provided. For business, their financial reports show changes in equity of the enterprise during the current period. Role of the Budget . For governments, a budget takes on a special legal significance. Governmental budgets are expressions of public policy priorities and legally authorize the purposes for which public resources may be spent. In fact, governmental budgets can be the primary method by which citizens and their ele cted representatives hold the government’s management financially accountable. For business enterprises, the budget represents an internal financial management tool that is controlled entirely by management and is considered proprietary in nature. b. 1. The purpose of the Government Finance Officers Association is to enhance and promote the professional management of governments for the public benefit by identifying and developing financial policies and best practices and promoting their use through educa tion, training, facilitation of member networking, and leadership . The objectives of the GFOA are: • Expert Knowledge. Continue to be recognized as a leading source of expert knowledge in public financial management by exercising leadership in research, recommended practice and policy development and information dissemination. • Education and Training. Enhance the expertise and professionalism of financial managers and policy makers and provide recognition for their achievements. • Leadership Development. Engage in efforts to assist finance officers to develop the skills and capabilities necessary to enable them to become organizational leaders as well as technical experts. • Raising Public Awareness of Sound Financial Policy and Practice. Take leadership in promoting public awareness of policies and practices that enhance sound financial management of public resources. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-6 • Enhanced Cooperation. Cooperate with and complement the services provided by other organizations (U.S., Canadian and international) to incre ase the effectiveness of GFOA. • Strategic Use of Technology. Provide information and analytical tools to help governments identify and apply appropriate, economical technologies to support efficient resource allocation, quality services and effective deci sion-making and to promote citizen involvement. • Association Operations. Conduct the operations of the Association in a manner that exemplifies the highest standards of financial management and member service. 2. The GFOA established the Certificate of A chievement for Excellence in Financial Reporting Program (CAFR Program) in 1945 to encourage and assist state and local governments to go beyond the minimum requirements of generally accepted accounting principles to prepare comprehensive annual financial reports that evidence the spirit of transparency and full disclosure and then to recognize individual governments that succeed in achieving that goal. Reports submitted to the CAFR program are reviewed by selected members of the GFOA professional staff and the GFOA Special Review Committee (SRC), which comprises individuals with expertise in public -sector financial reporting and includes financial statement preparers, independent auditors, academics, and other finance professionals. 3 The number of state a nd local governmental entities that were awarded the CAFR Certificate for the fiscal year 2016 are: Certificate of Achievement for Excellence in Financial Reporting 2016 Program Results: College/University - 84 Municipality - 2,078 Counci l of Government - 18 Employee Benefit - 173 County - 547 School District - 554 Enterprise Fund - 511 State - 43 Other 291 Total award recipients 4,299 http://www.gfoa.org/sites/default/files/FY2016CAFRStats.p df Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-7 Problems P. 1-1. a. The authority’s cash requirements in Year 1 would be as follows (in millions): Wages, salaries and other operating costs $6.0 Purchase of equipment $10.0 Less: Issuance of bonds 10.0 0.0 Interest on bonds 0.5 Purchase of additional equipment 0.9 Total cash outlays (revenue requirements) $7.4 b. In Year 2, they would be: Wages, salaries and other operating costs $6.0 Interest on bonds 0.5 Total cash outlays (revenue requirements) $6.5 c. In Year 10, they w ould be: Wages, salaries and other operating costs $6.0 Interest on bonds 0.5 Repayment of bonds 10.0 Total cash outlays (revenue requirements) $16.5 d. The budgeting and taxing policies fail to promote interperiod equity. The economic costs i ncurred by the authority — the wages, salaries, other operating costs, and portion of equipment consumed — were the same each year. Yet, tax payments will depend on when the equipment was purchased and when the debt was repaid. Taxpayers of Year 10 will ha ve to pay for equipment that provided services to the taxpayers of the previous nine years. Interperiod equity could be achieved by budgeting on an accrual rather than a cash basis. The budget would then include an annual charge of $1.3 million for deprec iation — $1 million on the ten -year equipment; $0.3 million on the three -year equipment. Annual required revenues would be $7.8 million: Wages, salaries and other operating costs $6.0 Interest on bonds 0.5 Depreciation on equipment 1.3 Total reven ue requirements $7.8 This practice might, however, be objectionable to some taxpayers because it requires that they contribute cash to the authority in years prior to those in which it will actually be expended. Thus, for example, at the end of Year 1 th e authority will have a cash “reserve” of $0.4 million — the difference between the $7.8 million in Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-8 taxes collected and the $7.4 million in cash outlays. The authority could also achieve interperiod equity by issuing serial bonds (those in which a portion of the principal matures each year over the life of the issue) or by establishing and contributing to a debt service “sinking fund.” By taking either of these approaches, the authority would, in effect, be repaying the bonds over the period in which the equipment is used and thereby matching equipment costs with equipment benefits. P. 1-2 1. The information provided should, by itself, pose no obstacle to approving the loan. For sure, revenues just cover expenditures, allowing for no excess to cover the deb t service on the loan and the additional operating expenditures that will be incurred when the classroom building is put into use. The key issue facing a loan officer, however, is whether the church members are both willing and fiscally able to pay for the new facility and to cover the additional operating costs. The fiscal capacity of the church cannot be assessed independently of that of its members. The financial statements reveal that the church’s assets will have a market value of $7.2 million (new an d old facilities plus cash and investments) when the classroom building is complete. If some or all of these assets are used to secure the loan, then the bank may have a reasonable cushion against default. However, market values of churches or other specia l-purpose facilities are notoriously unreliable. Moreover, for obvious reasons, banks are reluctant to foreclose on local churches. 2. The loan officer may wish to review the financial statements for “smoking guns” such as contingent liabilities, litigatio n, or unusual transactions. However, assuming that none are found, there is likely to be little in the financial statements to provide the basis for a loan decision. 3. If the loan officer were to approve the loan, he would likely do so in large measure because he has had a business relationship with members of the church and has confidence in their ability to manage the church and assure that the loan is repaid. Accordingly, he would probably want to review whatever information is available as to the chara cter and credit worthiness of key church members and officers. 4. As implied in part a, as a matter of policy the church, like many not -for-profit organizations, generates only enough revenues to meet its expenditures. If the members opt to enhance the lev el of services provided by the church by building a new facility — and thereby increase expenditures — then presumably they will also increase their dues and contributions. Financial statements of many not -for-profits are inadequate for making loan decisi ons because they report only on the entities themselves. However, the entities’ true fiscal condition cannot be determined apart from that of their constituents. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-9 P. 1-3 The objective of budgetary compliance can best be served by recording each transaction on the same basis as it is budgeted — in this case, on a modified cash basis. That of interperiod equity can best be achieved by identifying the economic substance of each transaction and recording it when it has its substantive economic impact — that is, on an accrual basis. 1. Budgetary compliance: No expenditure recognized in 2020 . Recognize the $128,000 in wages and salaries as an expenditure entirely when paid in 2021 . Interperiod equity: Recognize the amounts when earned, entirely in 2020 . 2. Budgeta ry compliance: Recognize cost of the pension contribution when the $170,000 payment was made in 2021 . Interperiod equity: Recognize the actuarially required pension contribution of $225,000 in 2020 , the year the employees earned the benefits, irrespective of the city’s actual cash contribution. 3. Budgetary compliance: R ecognize the vehicle cost when the cars were paid for, $105,000 in 2020 . Interperiod equity: R ecognize the vehicle cost over the three -year period in which the vehicles will be used, $35,0 00 per year. 4. Budgetary compliance: Recognize the $1,000 in interest revenue when received in 2021 , inasmuch as the interest revenue would increase the value of the marketable securities and marketable securities are included within the government’s defi nition of cash. Interperiod equity: Recognize the interest when earned, in 2020 . 5. Budgetary compliance: Recognize the expenditure for use of the building as the building is paid for, $400,000 per year for 25 years. Interperiod equity: Recognize the cos t of the building as it is used, irrespective of when it is paid for; in this case $400,000 per year for 25 years. 6. Budgetary compliance: Recognize the issuance of the bonds and the purchase of the building in 2020 . Recognize the expenditure for use of the building when it is paid for, $10 million in 2045 . Interperiod equity: As previously stated, recognize the cost of the building as it is used, irrespective of when it is paid for, in this case $400,000 per year for 25 years. 7. Budgetary compliance: R ecognize the entire $120,000 in license fee revenue in 2020 as cash is received. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-10 Interperiod equity: Recognize the license fee revenue over the period covered by the license and in which the related inspections will be carried out, thus $60,000 for the half-year of 2020 and $60,000 for 2021 . 8. Budgetary compliance: Recognize the $300,000 borrowed as a revenue when received in 2020 , and then as an expenditure when repaid in 2021 . Note that in this example, the increase in cash may be considered “other sour ces of funds” rather than as revenue. The impact on fund balance is the same, however. Interperiod equity: This transaction would result in an increase in cash and an offsetting increasing in a payable. No recognition would be given as a revenue or an expenditure to either the receipt of the amount borrowed or its subsequent repayment. P. 1-4 1. a. The statements are clearly silent as to the accomplishments of the university. Indeed, they give no indication either as to what the university’s objectives are or whether they have been met. b. Efficiency is a ratio of inputs to outputs (resources to results). Inasmuch as the statements do not report on results, the user can make no assessments as to efficiency. c. The statements give no information as to the na ture, condition or market value of the university’s physical properties. Equally significant they give no clues as to what the university’s plant requirements are for the present, let alone what they will be in the future. d. The statements provide no indi cation as to what the university’s fiscal requirements will be in the future. They say nothing, for example, about anticipated student enrollments, state appropriations, research grants, program requirements, etc. Accordingly, no comparison can be made bet ween 2020 and 2021 . e. The statements indicate that the ratio of cash to both short and long -term obligations is approximately the same in 2021 as it was in 2020 . Assuming that the cash balance was adequate for 2021 it appears that it will be adequate for 2022 . However, the statements give no indication as to whether cash inflows can be expected to be the same in the future as they were in the past or whether there will be new demands for cash (e.g., for maintenance and repairs or for new facilities or prog rams). 2. Each of the questions is consistent with the objectives. They demonstrate that the financial statements of not -for-profits, if limited to the types of data included in business -type statements, cannot possibly fulfill all the GASB or FASB objecti ves. These statements provide insufficient information to assess past performance or the Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-11 adequacy of current resources to meet future requirements. At the very least they would have to contain information on the entity’s goals and accomplishments. P. 1-5 1. Among governments that should be considered are towns, townships, cities, school districts, utility districts, road districts, library districts, hospital districts, community college districts , airport authorities and transportation districts. 2. The ov erlapping governments may rely on the same property or citizens for their tax revenues. Thus, to determine the “fiscal capacity” of one government it may be necessary to assess that of the others. For example, the outstanding debt of the school district mu st be taken into account in evaluating the borrowing capacity of the overlapping city, because the debt of both governments will have to be repaid from taxes on the same property. P. 1-6 a. (1) Inasmuch as the city budgets on a cash basis, delaying the pay ment o f bills by one week would reduce the budget deficit , shifting cost to the next year . It would have no impact on the accrual -based financial statements and only a very minor direct impact on the city’s substantive economic well -being (i.e., the city w ould have the use of the required cash for an additional few days). (2) Speeding -up recognition of property taxes would also reduce the budget deficit but have no impact on the financial statements and would shift revenue from one year to another . It would have no direct impact on the city’s substantive economic well -being as it would not affect the timing of actual cash collections. (3) Delaying the recognition of expenditures would also reduce the budget deficit, have no impact on the financial statements and have no impact on the city’s substantive economic well -being. Like speeding -up recognition of property taxes, it would not affect the timing of actual cash collections. (4) Deferring maintenance would reduce the budget deficit and reduce the expenditu res reported in the accrual -based financial statements. Assuming that the initially planned maintenance expenditures were necessary (and that the city’s maintenance schedule was optimal), the change would have a negative effect on the city’s substantive we ll-being. It would likely result in increased expenditures in the future. Each of these proposals may substantively affect the city’s financial well -being indirectly in that they would enable the city to legally balance its budget and thereby avoid the ad verse consequences of a deficit. Of course, sophisticated analysts might recognize the city’s measures as gimmicks and “one -shots” that would create fiscal pressures in the future. They might thereby downgrade the city’s credit rating or take other actions that would have a negative impact on the city’s fiscal well -being. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-12 b. Accounting principles do not directly affect an entity’s economic well -being. However, if they change the data presented in budgets or other financial reports that are relied upon to ma ke legal determinations, credit assessments, or other decisions, their indirect impact can be profound. As a consequence of those decisions the city can be denied loans or grants (or have to incur higher interest costs) or alter the allocation of its resou rces. P. 1-7 There are no clear -cut answers to these questions. It addresses an issue that has been on the GASB’s agenda since the board was first established and will be dealt with in greater depth later in the text in the chapter on business -type activit ies. 1. In a broad sense, the financial reporting objectives of the private company are likely to be similar to those of the government. Financial reporting should provide information on the past performance and current financial condition of the departmen t. To be sure, the owners of the private company measure performance in terms of profitability, whereas the citizens of the town are concerned mainly with “service” (subject to the constraint that costs are covered by fees). This difference alone may have important implications as to the types of data that are collected and how they are reported. From a practical perspective, however, the “traditional” information requirements — data on revenues, expenditures, assets and liabilities — are likely to be the s ame. 2. In light of the requirement that the department was expected to break -even, there are likely to be few operating differences between the information needs of the managers of the department as owned and operated by the private company as opposed to the town. P. 1-8 1. Assuming that the PAC is profit oriented and is thereby interested in maximizing the present value of incremental cash flows, the decision is straight -forward: Additional annual net cash flows: 20 students x 50 weeks x incremental r evenues of $ 30 ($130 less $ 100) $30,000 Present value of an annuity of $1 for 3 periods at 10 percent 2.4869 Present value of net cash flows $74,607 Because the present value of the incremental cash inflows exceeds the asset cost of $60,000, the PAC should acquire the asset. 2. The CYA, by contrast has no such convenient algorithm to rely upon. The key question faced by the CYA is whether alternative uses of the $ 60,000 would better enable it to fulfill its mission. The limited information provide d is inadequate to make a decision. Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-13 3. The objective of not -for-profits such as the CYA is to serve their communities, not to earn profits or maximize cash flows. Hence, the conventional discounted cash flow capital budgeting model is not appropriate becau se it focuses on cash flows. To be appropriate for a not -for-profit, a capital budgeting model would have to take into account the benefits that relate specifically to the organizations’ unique objectives. Nevertheless, for some capital budgeting decision s, the conventional discounted cash flow approaches may be appropriate. These would include purchase decisions, for example, when the benefits to be derived from the asset under consideration are cash savings rather than enhanced service. P. 1-9 1. Were th e city to accept the offer, its total savings would be only $8.1 million. Wages and salaries $4.0 Supplies 2.6 Other cash expenditures 1.3 Rent 0.2 Total savings $8.1 The cost of obtaining the service from the private company would be $8.5 million. Hence the offer should be rejected. For purposes of this decision, the cost of $8.9 million used to establish billing rates is not relevant. It includes allocated overhead costs, some of which could not be reduced were the city to accept the offer. 2. The t otal savings to the city would be unaffected by its allocation policy. They would remain at $8.1 million. Therefore, if the offer were rejected when costs were allocated, it should also be rejected when costs were not allocated. The $7.9 million is no more relevant than the $8.9 million. The relevant amount is still the $8.1 million in expected savings. There may be sound reasons for the city to allocate overhead costs for purposes of establishing billing rates. However, the allocated costs are not relevan t for the decision whether to perform a service internally or acquire it externally. P. 1-10 a. 1. The reported pension cost should be based on the actuarially required contribution, not on the actual cash contribution. 2. The contribution to the rainy -day reserve should be accounted for as an internal designation of resources. The accounting should make clear that total Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-14 assets of the government are not affected by the arbitrary, nonbinding management decision to set aside cash for a particular purpose. Thu s, the transfer should affect only asset accounts, not revenues or expenditures. 3. The securities should be accounted for at market value. In that way the gain would not be recognized entirely in the year of sale — a year in which increase in market price did not necessarily take place — and management could not pick the year to enhance its revenues. 4. The city could automatically report an annual maintenance expenditure equal to some predetermined amount (perhaps an average of expenditures over the previ ous five years.) The charge would be offset by a liability (e.g., “deferred maintenance”), which would be reduced only by actual maintenance outlays. b. A fundamental objective of financial reporting is to report on budgetary compliance. To the extent that the financial reports are on an accrual basis whereas the budget is on a cash basis, they would not achieve this objective. Moreover, the reported expenditures, for both maintenance and (though to a lesser extent) pensions could be considered arbitrary — that is, not based on specific transactions. P. 1-11 1. Per capita debt (before change) = debt/population $1,200,000,000/800,000 = $1,500 2. Per capita debt (after change) = $1,800,000,000/800,000 = $2,250 3. a). The change in the accounting principle will increase the reported liability, but it will have no direct impact on the city’s fiscal condition. The promises to employees and retirees will remain the same; hence future cash flows will also remain the same. Only the way “the story” is told will change. b). Assuming that the notes to the financial statements provided the same information that would now be reported on the balance sheet, there is no reason why the analyst should change the city’s bond rating. The analyst would have been (or most certainly should have been) aware of the existence, as well as the magnitude, of the pension obligation. If, however, the new rules required that the liability be computed differently and thereby better captured its true economic value the financial stat ements would have provided the analyst with improved information. This new information might give the analyst reason to change the rating. Questions for Research, Analysis and Discussion 1. The GASB in 2006 issued a “white paper,” “ Why Governmental Acc ounting and Financial Reporting Is —and Should Be —Different,” which as implied by the title sets forth numerous reasons as to why governments are unique and therefore justify their own standard -setting organization. The characteristics identified include: Granof , Khumawala , Calabrese & Smith 8e, Gov ernment and Not -for-Profit Accounting 1-15 • Organizational purposes • Sources of revenue • Relations with stakeholders • Potential for longevity • Role of the budget In addition the report points to several other differences in how governmental accounting differs from business accounting: • The reporting model has several unique features. • There are special issues of how to define the reporting entity. • Long -lived assets have different purposes (e.g., in governments they are not intended to generate cash flows). • They engage in numerous types of nonexchange transactions. The GASB white paper is available on the organization’s web site. Not-for-profit entities , obviously have many of the characteristics of both governments and businesses. Some, like agricultural cooperatives, country clubs or hospitals, ar e virtually the same as businesses. Others, such as health and welfare organizations have more of the characteristics of governments. In reality, not -for- profit entities could legitimately be placed with in the purview of either the GASB or the FASB. The decision to place not -for-profits with in the purview of the FASB was influenced more by “political” considerations than by any fundamental organizational characteristics. 2. The GASB in its Concepts Statement No. 1, Objectives of Financial Reporting, explicitly recognizes that “Financial reporting should provide information to assist users in assessing the service efforts, costs, and accomplishments of the governmenta l entity.” Moreover, it had devoted Concepts Statement No. 2, Service Efforts and Accompl ishments (SEA) Reporting entirely to this objective. After 20 years of conducting research and constituent outreach on SEA reporting, GASB issued in 2009 the revised and updated version of its C oncepts Statement No. 2, Service Efforts and Accomplishments Reporting As Amended by GASB Concepts Statements No. 3 and No. 5 and offers the strongest endorsement to date of enhanced SEA reporting. It has long been the position of many GASB members and constituents that information on service efforts and accomplish ments (SEA) should indeed be incorporated into comprehensive annual financial reports. Nevertheless, many other constituents of the GASB believe that, even though, information on SEA is important, it does not relate directly to financial reporting and sho uld be reported in separate statements. Accordingly, the GASB has not yet formally proposed incorporating SEA information in the Comprehensive Annual Financial Report (CAFR). 2-1 Chapter 2 Fund Accounting Questions for Review and Discussion 1. In governmental accounting, a fund is a fiscal and accounting entity with a self - balancing set of accounts used to account for an organization’s resources and claims against those resources. In business accounting, by contrast, funds generally refer either to working capital (current assets less current liabilities) or to selected components of working capital. 2. The accounting equation as applied in government ac counting differs from business accounting, and is defined as assets + deferred outflows = liabilities + deferred inflows + fund balance . For not -for-profits, the equation is assets = liabilities + fund balance . In both cases, the equations indicate that un like businesses, there are no “owners” of governments or not -for-profit organizations. 3. Nonspendable fund balance includes amounts that are not in spendable form or are required to be maintained intact. Restricted fund balance includes amounts constrained to specific purposes by their providers, through constitutional provisions, or by enabling legislation. Committe d fund balance includes amounts constrained to specific purposes determined by the highest decision -making authority of the government itself. Assigned fund balance includes amounts a government intends to use for a specific purpose. 4. GASB in 2007 in Conce pts Statement No. 4 Elements of Financial Statements provided definitions and explanations of seven key elements that comprise basic financial statements —five relating to financial position (assets, liabilities, deferred outflow of resources, deferred inflow of resources and net position) and two relating to resource flows. These elements as defined by GASB are: “Assets are resources with present service capacity that the government presently controls. ” “Liabilities are present obligations to sacrifice resources that the government has little or no discret ion to avoid.” “A deferred outflow of resources is the consumption of net assets by the government that is applicable to a future reporting period.” “A deferred inflow of resources is the acquisition of net assets by the government that is applicable to a future reporting period.” “Net position is the residual of all other elements presented in a statement of financial position; that is the assets and deferred outflows less the liabilities and deferred inflows.” “An outflow of resources is a consumption of net assets by the government that is applicable to the reporting period.” An inflow of resources is an acquisition of net assets by the government that is applicable to the reporting period . 5. Governments establish funds neither to account for specific functions nor to divide evenly their resources. Instead, they create funds mainly to promote control and Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-2 accountability over restricted resources. The general fund of the city is probably larger than all of the special revenue funds combined because most o f the city’s assets are unrestricted and the unrestricted assets can be aggregated in a single fund. 6. There are no capital projects reported in the capital projects fund and generally no long-term debts reported in the debt service fund because these funds are maintained to account for the resources that will be used to construct or acquire capital assets or to pay the interest and principal on long -term debts. These resources are set apart from other resources because they can only be used for their specifi ed purposes. 7. The presence of long -lived assets and long -term debt on the balance sheets of enterprise and internal service funds indicates that the assets and debts are within the funds’ measurement focus. It thereby implies that the funds are on a full ac crual basis . 8. Proprietary funds are used to account for business -type activities and they adhere to business -type accounting principles. They typically charge for the goods or services they provide and need data on the full cost (including depreciation) of services provided so that they can establish prices. Governmental funds, by contrast, are accounted for on a modified accrual basis. They receive their revenues from taxes, grants and other sources that are not necessarily tied to cost of service. 9. Fiduci ary funds are used to account for resources held by the government as either a trustee (a party that administers property for a beneficiary) or an agent (one who act s on behalf of another). The four main types are pension and other employee benefit trust funds , investment trust funds, private purpose trust funds, and custodial funds. Trust funds are used to account for assets that the government holds for the benefit of parties other than the government itself (retirees, other governments, and others) . Custodial funds are used to account for assets (e.g., taxes collected by one government on behalf of another) that a government holds temporarily for other entities . 10. Permanent funds are a type of trust fund, but they benefit the government itself, rather than outside parties. Therefore, they are considered governmental funds, not fiduciary funds. However, like fiduciary funds, only the income of a permanent fund, not the principal, may be spent. The principal must remain permanently intact. 11. The financial statements must be prepared from a government -wide and a funds perspective. The government -wide financial statements are consolidated and are on a full accrual basis. The funds perspective statements are combined. The governmental funds are accounted for o n a modified accrual basis; the proprietary funds on a full accrual basis. 12. A custodial fund is used to account for assets held on behalf of other governments, funds or individuals, usually for a short period, such as a year. Because the money is held for o ther entities, custodial funds have only assets and liabilities, no revenues and expenditures. Custodial funds hold taxes collected by one government intended for another government (such as a sales tax), a grant intended for another government or entity, among other examples. Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-3 13. A CAFR is a government’s Comprehensive Annual Financial Report. Its main components are an introductory section (that includes a letter of transmittal and a GFOA (Government Finance Officers Association) C ertificate of Achievement for Excellence in Financial Reporting ( if received), a financial section (that includes management’s discussion and analysis, the financial statements, notes to the financial statements and required supplementary information) and a statistical s ection (that includes economic, demographic and financial data). 14. Resources with donor restrictions are those that must be used for a specific purpose (e.g., to support donor -desig nated programs or activities), cannot be spent until some time in the future (e.g., when a donor makes good on a pledge), or are restricted in perpetuity (such as an endowment) in which only the earnings can be spent. Funds without donor restrictions , of course, are not subject to such restrictions. The restrictions are based on do nor mandates. Hence, restrictions imposed by other parties (e.g., creditors) are not taken into account for purposes of resource classification. These guidelines apply to not -for-profits, not governments and are based on FASB rather than GASB pronouncemen ts. Exercises EX 2 -1 1. j 2. g 3. a 4. h 5. a 6. b 7. a 8. i 9. a 10. f EX 2 -2 1. a 2. c 3. d 4. d 5. c 6. a 7. a 8. b 9. c 10. b 11. a Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-4 12. b EX 2 -3 a. Focus on cash (1) No entry necessary — no cash involved. (2) Cash $ 300,000 Contribution revenues $ 300,000 To record the partial collection of the note (3) Building acquisition expenditure $ 120,000 Cash $ 120,000 To record the cash paid to acquire the building (4) No entry necessary — no cash involved Focus on cash plus current financial resources (1) Note receivable $1,000,000 Contribution revenue $1,000,000 To record the note received (2) Cash $ 300,000 Note receivable $ 300,000 To record the partial collection of the note (3) Building acquisition expenditure $ 120,000 Cash $ 120,000 To record the cash paid to acquire the building (No recognition is given to the long -term note or to the building, a long -term asset.) Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-5 (4) Wage expen se $ 4,000 Wages payable $ 4,000 To record the wages earned by employees, but not yet paid. Focus on all economic resources (1) Note receivable $1,000, 000 Contribution revenue $1,000,000 To record the note received (2) Cash $ 300,000 Note receivable $ 300,000 To record the partial collection of the note (3) Building $ 600,000 Cash $ 120,000 Mortgage note payable 480,000 To record the acquisition of the building Depreciation expense $ 20,000 Accumulated depreciation $ 20,000 To record depreciation on the building (4) Wage expen se $ 4,000 Wages payable $ 4,000 To record the wages earned by employees, but not yet paid Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-6 b. Statement of Revenue and Expen ses Current All Financial Economic Cash Resources Resources Contribution revenue $300,000 $1,000,000 $1,000,000 Building acquisition expen se (or depreciation) 120,000 120,000 $ 20,000 Wage expen se 0 4,000 4,000 Total expen ses 120,000 124,000 24,000 Excess of revenues over expen ses $180,000 $ 876,000 $ 976,000 Balance Sheet Current All Financial Economic Cash Resources Resources Assets Cash $180,000 $ 180,000 $ 180,000 Note receivable 700,000 700,000 Building (less accumulated depreciation) 580,000 Total assets $180,000 $ 880,000 $1,460,000 Liabilities and fund balance Wages payable $ 4,000 $ 4,000 Mortgage note payable 480,000 Fund balance $180,000 $ 876,000 976,000 Total liabilities and fund balance $180,000 $ 880,000 $1,460,000 EX 2 -4 1. Journal entries in general fund (in millions) (1) Cash $20.0 Proceeds from borrowing $20.0 To record the issuance of bonds Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-7 (2) Expenditure for land $ 4.0 Cash $ 4.0 To record the purchase of land (3) Cash $ 1.0 Proceeds from sale of land $ 1.0 To record sale of land (4) Repayment of bonds (expenditure) $ 2.0 Cash $ 2.0 To record repayment of bonds (5) Legal claims (expenditure) $ 3.0 Cash $ 3.0 To record payment of judgment Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-8 2. Modified accrual statements Special District Balance Sheet Cash $12 Fund Balance $12 Special District Statement of Revenues, Expenditures and Changes in Fund Balance Revenues and other financing sources Bond proceeds $20 Proceeds from sale of land 1 Total revenues and other financing sources 21 Expenditures and other financing uses Repa yment of bonds 2 Acquisition of land 4 Legal claims 3 Total expenditures and other financing sources 9 Excess of revenues and other financing sources over expenditures and other financing uses $12 3. The balance sheet fails to capture key long -term assets and long -term obligations. But, of course, it is not intended to do so. Instead, it is intended to indicate the current financial resources available to meet current obligations. 4. Similarly, the sta tement of revenues, expenditures and other financing sources does not measure the cost of services (e.g., it recognizes borrowings as an increase in fund balance and the full cost of acquiring fixed assets as a decrease). It is not designed to do so. Inste ad it is designed to report on flows of current financial resources — net assets that are likely of great interest to the district’s governing body, managers and constituents. Granof , Khumawala , Calabrese & Smith 8e, Government and Not -for-Profit Accounting 2-9 EX 2 -5 a. Journal entries (1) Cash $160,000 Contribution revenues $160,000 To record contribution revenue (general fund) Cash $ 40,000 Contribution revenues $ 40,000 To record contribution revenue (building fund ) (2) Operating expenses $130,000 Cash $120,000 Accounts payable 10,000 To record operating expenditures (general fund) (3) Cash $ 3,000 Interest revenue $ 3,000 To record interest revenue (building fund) (4) Transfer to building fund $ 17,000 Cash $ 17,000 To record transfer -out to building fund (general fund) Cash $ 17,000 Transfer -in from general fund $ 17,000 To record transfer -in from general fund (building fund) (5) Expenses for architectural services $ 12,000 Cash $ 12,000 To record fees paid to architect (building fund)