CHAPTER 16
ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS
(PART ONE)
Chapter Outline
I. State and local government units are different than for-profit entities in a number of specific
ways.
A. Governments serve a broader group of stakeholders.
B. Most government revenues are raised through involuntary taxes and tolls.
C. Monitoring compliance with budgeted public policy priorities is central to public
accountability.
D. Governments exist longer than for-profit businesses.
E. The primary purpose of governments is to enhance or maintain the well-being of its
citizens.
II. State and local government units produce two complete and distinct sets of financial
statements.
A. User needs for governmental financial information are so diverse that the Governmental
Accounting Standards Board (GASB) requires two sets of statements to be prepared.
The fund financial statements are more for the citizens whereas the government-wide
statements are more for investors, such as bondholders.
B. Fund financial statements are designed primarily to present information about the
General Fund and other major activities. This approach stresses the government’s fiscal
accountability over its financial resources.
a. For governmental funds, all current financial resources and claims to those financial
resources are presented using modified accrual accounting for timing purposes.
b. For proprietary funds and fiduciary funds, all economic resources are reported using
accrual accounting for timing purposes.
C. Government-wide financial statements (a statement of net position and a statement of
activities) are designed to present an overview of the government as a whole and
emphasizes operational accountability.
a. In these statements, all economic resources are measured using accrual accounting
for timing purposes.
b. The governmental funds and most of the internal service funds are combined and
reported together as governmental activities.
c. The enterprise funds and any remaining internal service funds are combined and
reported as business-type activities.
d. Because the government does not have control over the use of the assets held in the
fiduciary funds, they are excluded from the government-wide financial statements.
III. For internal purposes, governmental accounting records its individual activities within a
number of self-balancing sets of accounts known as funds.
A. Governmental funds account for activities where service to the public is the main
emphasis.
a. General fund
b. Special revenue funds
c. Capital projects funds
d. Debt service funds
e. Permanent funds
B. Proprietary funds account for activities of the government where a user charge is
assessed.
a. Enterprise funds
b. Internal service funds
C. Fiduciary funds account for assets held in a trustee capacity for external parties.
a. Investment trust funds
b. Private-purpose trust funds
c. Pension trust funds
d. Agency funds
IV. In reporting current financial resources and the claims to the current financial resources of a
governmental fund, the Fund Balance account indicates the use that can be made of these
resources by government officials.
A. Fund-Balance—Nonspendable – the amount of resources reported by a fund that cannot
be spent by government officials.
B. Fund-Balance—Restricted – the amount of resources held by a fund that must be spent
in a manner designated by an external party.
C. Fund-Balance—Committed – the amount of resources designated for a particular
purpose by the highest level of decision-making authority in the government.
D. Fund-Balance—Assigned – the amount of resources designated for a particular purpose
internally but not by the highest level of decision-making authority.
E. Fund-Balance—Unassigned – the amount of resources where no use has yet been
specified. This is only found in the General Fund because resources only appear in
other funds if there is some intended use for them.
V. Governmental accounting has traditionally stressed establishing control over current
financial resources to ensure appropriate usage of the public’s money.
A. Budgets are required to be approved by the citizens of the government, represented by
the governing body – for example, city council, state legislature. When amendments are
made to the budget, the governing body has to approve them also.
B. Budgetary entries are recorded for a number of the activities within the governmental
funds.
a. The entry is recorded at the start of the year and is then reversed to remove at the
end of the year.
b. Budget amendments may be recorded during the year.
C. Financial commitments (such as contracts and purchase orders) are recorded during
the year as encumbrances.
a. These entries help avoid overspending of appropriated amounts.
b. Encumbrances are removed from the records when the commitment becomes a
liability.
VI. In government-wide financial statements, acquiring a capital asset is reported as a capital
asset and incurring an expense is reported as an expense in the same manner as a for-
profit business. However, in reporting the governmental funds within the fund financial
statements, the purchase of a capital asset, incurrence of an expense, and payment of a
noncurrent debt are all reported as expenditures to reflect the reduction in current financial
resources. Through this reporting, the statements report the usage made of the current
financial resources held by the government activity.
A. On the fund financial statements, supplies and prepaid items can be reported by either
the consumption method (expenditure is recorded as the acquired item is consumed) or
the purchases method (expenditure is recorded when liability is incurred). The
consumption method is required for the government-wide statements.
B. On the government-wide financial statements, acquisitions of infrastructure items —such
as bridges and sidewalks— are required to be recorded as capital assets.
VII. Governments often have nonexchange transactions where revenues such as taxes and
grants are received without a corresponding earning process. To guide the timing of
recognition of such transactions, four separate categories have been identified.
A. Derived tax revenues—such as income taxes and sales taxes—are recognized when the
underlying event occurs.
B. Imposed nonexchange transactions—such as property taxes, fines, and penalties—are
recognized as revenues when the resources are required to be used or in the first period
when use is permitted.
C. Government-mandated nonexchange transactions, usually a government grant to fulfill a
legally required objective, are recognized when all eligibility requirements have been
met.
D. Voluntary nonexchange transactions—such as most grants and gifts—are recognized
when all eligibility requirements have been met.
VIII. Governments often raise significant amounts of financial resources by issuing long-term
bonds.
A. In the government-wide financial statements, the debt is a liability on the Statement of
Net Position.
B. In the fund financial statements for the governmental funds, the inflow of financial
resources is reported as an “other financing source.” Eventual payment of the debt is
shown as an expenditure. Noncurrent debt balances are not shown in the fund financial
statements for the governmental funds.
IX. Transfers are separated into three categories: intra-activity transactions, interactivity
transactions, and internal exchange transactions.
Answer to Discussion Question
Is it an Asset or a Liability?
Even after more than 20 years, Mautz’s comments go straight to the problem posed by
government accounting. State and local governments are just fundamentally different than for-
profit businesses.
years to come. A business constructs a building in hopes of generating significant net cash
inflows. Government officials are aware that the costs of maintenance, heating, etc. of the
school will far outweigh any direct cash inflows. Hence, Mautz’s question—is it an asset or a
liability—is not easy to answer. Governmental accounting solves this issue in a very unique
article described here.
Answers to Questions
1. Individuals and groups who seek information about a state or local government have needs
that are often complex and contradictory. Specific procedures in the governmental reporting
2. Accountability and control have been a constant goal of governmental accounting over the
decades. Governmental accounting provides the citizenry of a democracy with a method for
3. The traditional approach of government accounting places its priority on individual
accountability for the various separate government activities. Unfortunately, the resulting
information has not necessarily met all user needs (especially the needs of bond investors
4. Two financial statements make up the government-wide financial statements: The Statement
of Net Position and the Statement of Activities. There are a number of fund financial
5. In fund accounting, governmental funds use the current financial resources measurement
focus and the modified accrual basis for the timing of revenue and expense recognition.
Current financial resources include assets such as cash, receivables, and investments that
can be used for spending. Reported liabilities are ones to be paid from current resources.
6. Government-wide financial statements use the economic resources measurement focus and
7. Current financial resources are primarily cash, investments, and receivables because they
8. Liabilities are recognized under the current financial resources focus when a claim against
current financial resources is created. That normally means that a debt is owed and
9. Governmental Funds: Account for activities with a service orientation
a. General Fund
b. Special Revenue Fund
c. Capital Projects Fund
10. The following fund types fall within the governmental funds classification:
a. The General Fund is used to account for ongoing activities such as public safety and
sanitation. More specifically, the General Fund records any activities that do not fall
under one of the other fund types.
11. The following fund types fall within the proprietary funds classification:
a. An Enterprise Fund accounts for any governmental activity that is open to the public and
financed in whole or in part by user charges, such as a subway system or a toll road.
12. Fiduciary Funds: Account for monies held by the government in a trustee capacity.
a. Investment Trust Fund. Accounts for the outside portion of investment pools where the
reporting government has accepted funds from other governments resulting in a larger
investment and hopefully a higher return.
13. In government-wide financial statements, financial figures are shown as either governmental
activities or business-type activities. All governmental funds and most internal service funds
are included within the governmental activities. All enterprise funds and any remaining
14. In fund financial statements, for governmental funds, a separate column must be shown for
(a) the General Fund, (b) any other fund that qualifies as major, and (c) all remaining funds
accumulated as a whole.
15. Fund-balance—nonspendable – provides the balance for all current financial resources that
cannot be spent by government officials. Prepaid items and supplies, for example, cannot
be spent by their very nature. Resources conveyed to a government where only
subsequent income can be spent also fall into this category.
16. The physical recording of a budget is viewed as a method of disclosing government policies
and financial intent, providing a financial plan for the period. The budget establishes
spending limitations, which enhances financial planning and control. The adoption of the
17. Comparisons between the original budget, the final budget (as amended), and actual figures
must be reported in the required supplemental information presented after the notes to the
18. An encumbrance is the recording of a purchase commitment (such as a contract or a
purchase order). The encumbrance entry is recorded at the time the commitment is made
prior to incurring a liability. This recording supports the spending control emphasis of the
19. Expenditures include outflows or reductions of net current financial resources from the
acquisition of goods or services (or the payment of a noncurrent liability). Modified accrual
20. Modified accrual accounting recognizes expenditures when a claim against the current
21. Within the governmental funds, fund financial statements focus on expenditures rather than
expenses or capital assets. Expenditures should be recorded when the related liability is
22. Traditionally, in government accounting, the purchases method has been used for prepaid
items and supplies. The cost is recorded immediately as an expenditure when the liability is
incurred. Any assets that remain at the end of the period are inserted into the records along
with an offsetting increase to “Fund Balance-Nonspendable.”
23. The four classifications of nonexchange revenues that a state or local government can
recognize are:
a. Derived tax revenues. A tax assessment is imposed because an underlying exchange
takes place. The revenue is recorded at the time of the underlying event. For example,
revenues are recognized for a sales tax when a sale occurs and the tax is imposed.
b. Imposed nonexchange revenues. An assessment is imposed but no underlying
transaction takes place. Examples include property taxes and fines or penalties that are
24. A receivable is not recorded for property taxes until the demand for money represents an
enforceable legal claim, which is normally specified by state or local laws. Many
governments encourage early payment of property taxes (by sending out bills early or by
giving some type of a cash discount). Thus, cash can actually be reported before the
government even records the initial receivable.
25. No revenues are recognized in either set of financial statements because the proceeds of
bonds must be repaid. In fund financial statements, Cash is increased along with an “Other
Financing Sources” figure. For example, if the bonds were issued for a construction project,
26. A special assessment is an improvement made to property by a government, which is paid
for in part or in whole by the owners of the property being benefited. Adding curbing and
sidewalks to a local street is an example of a special assessment if the residents of that
street are required to pay a portion of the cost. Typically, the government places a lien on
the property to insure payment.
27. In fund financial statements, interfund transactions are recorded in both funds
simultaneously at the time of authorization. For example, monetary transfers from the
General Fund to another fund such as the Debt Service Fund are recorded in both funds.
28. Intra-activity transactions occur totally within the governmental activities or totally within the
business-type activities so that no net effect is created for that group of funds. Therefore,
these transfers do not appear in the reporting of government-wide financial statements.
29. An internal exchange transaction is a transfer within the government that is recorded as if
the transaction had actually occurred with an outside party. Such transactions occur
between one of the government’s activities and an internal service or enterprise fund and
are paid for work or services rendered. These exchanges are reported as revenues and as
Answers to Problems
1. B (Internal service fund is a proprietary fund)
9. D (Capital assets are not reported as assets in the fund financial statements
of the governmental funds. Only current financial resources as well as
prepaid items and supplies are reported as assets in this set of financial
statements.)
12. B (As a governmental fund, the General Fund records expenditures rather
than expenses.)