Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-1
CHAPTER 2: PRINCIPLES OF ACCOUNTING AND FINANCIAL
REPORTING FOR STATE AND LOCAL GOVERNMENTS
OUTLINE
Number
Topic
Type/Task
Status
(re: 18/e)
Questions:
2-1
Communicating financial information
Compare
New
2-2
Service activities categories
Identify
Revised
2-3
Financial report differences
Compare
New
2-4
Modified accrual accounting
Compare
Revised
2-5
Fund categories
Identify
Same
2-6
Purpose of funds
Explain
Same
2-7
Deferred inflows and outflows of resources
Recall
Revised
2-8
Expenses/Expenditures
Compare
Same
2-9
Fund balance classifications
Identify
Same
2-10
Major fund criteria
Define
Same
Cases:
2-11
Accounting and reporting principles
Analysis
Revised
2-12
Evaluation of a city’s basic financial
statements
Evaluate
Revised
2-13
Fund balances
Describe
Same
2-14
Financial reporting model
Summarize
New
Exercises/Problems:
2-15
Examine the CAFR
Examine
Same
2-16
Various
Multiple Choice
1, 3, 6, 11,
and 12 are
new; other
items are
same
2-17
Matching fund types with fund categories
Classify
Same
2-18
Matching government-wide and fund financial
Classify
Revised
reporting characteristics
2-19
Matching transactions with funds
Classify
Revised
2-20
Fund balance classifications
Analyze
Revised
2-21
Determination of major funds
Analysis; calculate
Same
2-22
Determination of major funds
Analysis; calculate
Same
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-2
CHAPTER 2: PRINCIPLES OF ACCOUNTING AND FINANCIAL
REPORTING FOR STATE AND LOCAL GOVERNMENTS
Answers to Questions
2-1. In answering this question, students can provide various examples of required
supplementary information and other supplementary information to help support their
answer. One example is provided in the solution below.
GASB Concepts Statement No. 3 defines RSI as information that is essential to placing
the financial statements and related notes in their proper context. RSI is a higher order of
communicating information than is other “supplementary information.” Supplementary
information is useful when trying to understand the financial statements and related notes
but it is not essential to their understanding. A good example of RSI is the MD&A, which
General Problem Information: Communicating financial information
Learning Objective: 2-1
Topic: Conceptual Framework—Providing Useful Financial Reports
Bloom’s Taxonomy: Understand
2-2. The three activity categories common to most general purpose governments are
governmental, business-type, and fiduciary. Governmental activities include
administrative support and core government services, such as public safety, public works,
culture and recreation, and health and welfare. Business-type activities are activities that
are generally intended to be self-supporting, such as public utilities. Fiduciary activities
are those where the government acts as a trustee or custodian for parties outside the
government. These activities, which do not directly benefit the government, include such
activities as pension trusts, investment trusts, and tax collection.
General Problem Information: Service activities categories
Learning Objective: 2-2
Topic: Activities of Government
2-3. The government-wide statement of activities differs from the governmental fund
statement of revenues, expenditures, and changes in fund balance in at least
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-3
Ch. 2, Answers, Question 2-3 (Cont’d)
three key ways: the basis of accounting and measurement focus used to provide the
information for the statements, the level at which the information is provided, and the
presentation formats used by the statements.
• The statement of activities is prepared on an accrual basis of accounting with an
economic resources measurement focus. This results in information being recognized
and reported similar to a business entity. The statement of activities recognizes
• The statement of activities reports on an entity-wide basis, thus providing an
aggregate view of the government’s governmental activities (captured by the
activities of the governmental funds) and business-type activities (captured by the
• Finally, the presentation formats are quite different. The statement of activities starts
by identifying the functional expenses of the government and from these expenses it
deducts program revenues to arrive at a net expense or revenue for each function
identified. To the net expense/revenue, general revenues are added, along with any
General Problem Information: Financial report differences
Learning Objective: 2-3
Topic: Financial Reporting Model
Bloom’s Taxonomy: Understand
Accreditation Skills tag: AACSB: Communication, AICPA: BB Industry
Level of Difficulty: Medium
2-4. The modified accrual basis of accounting records revenues when they are measurable and
available for use in paying current period obligations, while expenditures are recorded
when an obligation has been incurred that will be paid from current financial resources.
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-4
Ch. 2, Answers, Question 2-4 (Cont’d)
obligations. Further, the accrual basis uses expense accounting, which recognizes an
expense when a resource is used in the provision of a good or service.
Because governmental fund financial statements focus on fiscal accountability, the
modified accrual basis of accounting allows for reporting on current sources and uses of
financial resources as opposed to the longer-term view provided by accrual accounting.
General Problem Information: Modified accrual accounting
Learning Objective: 2-3
Topic: Financial Reporting Model
2-5. The three categories of funds are governmental, proprietary, and fiduciary. The fund
types included in each category are shown below:
Governmental
Proprietary
General Fund
Special revenue funds
Debt service funds
Enterprise funds
Internal service funds
General Problem Information: Fund categories
Learning Objective: 2-4
Topic: Fund Reporting
2-6. Governmental accounting systems must provide both reporting in accordance with GAAP
and reporting to determine and demonstrate compliance with finance-related legal and
contractual requirements. To ensure that both GAAP and compliance reporting
requirements are met, a separate accounting mechanism is used. The mechanism that is
used is fund accounting, which makes it possible to ensure that the compliance reporting
requirement is met.
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
Ch. 2, Answers, Question 2-6 (Cont’d)
General Problem Information: Purpose of funds
Learning Objective: 2-3
Topic: Financial Reporting Model
2-7. Deferred outflows of resources are resources that have been consumed but are applicable
to a future reporting period (e.g., costs related to a debt refunding). Deferred inflows of
resources are resources that have been acquired but are applicable to a future period (e.g.
resources received but unavailable for use until a future period). These accounts, used
only when required by a GASB standard, represent timing differences between the actual
outflow or inflow of cash and the time period to which they apply.
Deferred outflows of resources are shown on the balance sheet or the statement of net
position below total assets but before liabilities. Because deferred outflows of resources
increase net position they have a normal debit balance. Deferred inflows of resources are
shown on the balance sheet or the statement of net position below total liabilities but
before fund balances or net position. Because deferred inflows of resources decrease net
position they have a normal credit balance.
General Problem Information: Deferred inflows and outflows of resources
2-8 Expenditures report actual outlays of funds, whether for an operating cost or the purchase
of an asset. Expenses focus on costs necessary to generate revenues or fund operations,
and may be a result of the using up or expiration of an asset, even if no cash was paid out.
General Problem Information: Expenses/Expenditures
Learning Objective: 2-3
Topic: Financial Reporting Model
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-5
2-9. The governmental fund balance classifications and an example for each are provided
below. There are numerous examples of what could be included in each classification;
therefore, consideration should be given to whether the student’s answer appropriately
fits the definition for the fund balance classification.
Nonspendable: This would include items such as endowments and prepaids (including
inventory).
Assigned: These are items that the government intends to use for specific purposes but
for which formal legislative action has not been taken. Items could be similar to those
found under committed fund balances. Additionally, it would include any fund balances
in special revenue, capital projects, debt service or permanent funds that have not been
Topic: Fund Reporting
Bloom’s Taxonomy: Apply
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Medium
2-10. The GASB requires that any fund that meets the following relative size criteria be
designated as major:
a. Total assets and deferred outflows of resources, liabilities and deferred inflows of resources, revenues
or expenditures/expenses of that governmental or enterprise fund are at least 10 percent of the
corresponding element total (assets and deferred outflows of resources, liabilities and deferred inflows
of resources, and so forth) for all funds of that category or type (that is, total governmental or total
enterprise funds), and (emphasis added)
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
Ch. 2, Answers, Question 2-10 (Cont’d)
General Problem Information: Major fund criteria
Learning Objective: 2-4
Solutions to Cases
2-11. A quick look at these financial statements reveals that the statements clearly do not
conform to the GASB reporting model.
a. It appears the accrual basis of accounting was used. There are at least three items
reported that would appear on statements prepared using accrual accounting but
would not appear if modified accrual accounting was used. The three items are the
capital asset accounts (Land, buildings and equipment), noncurrent liabilities, and
expenses (modified accrual would record expenditures).
financial statements:
1. Governmental fund financial statements: balance sheet, and statement of
revenues, expenditures and changes in fund balances.
2. Proprietary fund financial statements: statement of net position, statement of
revenues, expenses and changes in fund net position, and statement of cash
c. The format seems most similar to the government-wide statements in that all three
funds are being reported on the statements using what appears to be the accrual
basis of accounting. To conform with the government-wide financial statements
many changes would be needed:
2. Additional detail on noncurrent liabilities needs to be included. It is unclear
whether any of the amount provided is due within a year.
4. Additionally, the net position information would need to be classified as net
position-restricted, net position-net investment in capital assets, and net
position-unrestricted. The terms being used in the presented financial
statements are not used, as presented, in any reporting models.
5.
Ch. 2, Solutions, Case 2-11 (Cont’d)
2-7
6. The statement of activities is not in the cost of services format recommended
by GASB, where the expenses are adjusted for program revenues (such as
charges for services) to determine the net expenses from which general
revenues (such as taxes) are deducted (see Illustration A2-2, for example).
7. Expense detail is lacking. More functional detail is needed under
“Government services,” such as general government, public safety, public
works, and other relevant functions, so the amounts expended for each service
area can be determined. This may also reduce the relatively large amount
reported as “Miscellaneous.”
General Problem Information: Accounting and reporting principles
Learning Objective: 2-3
2-12. a. Based on the description of this city’s financial statements in the MD&A, the
statements appear to conform fairly well to GASB standards, with some minor
exceptions that require clarification. Specifically:
Government-wide Financial Statements
• Report governmental and business-type activities in separate columns.
• However, the city is reporting internal service funds as part of business-type
activities. Internal service funds are generally included as governmental activities,
and without further explanation it would be expected that is where the funds
would appear (see Illustration 2-2 in the text).
Fund Financial Statements
• Provide detailed information about major funds. All nonmajor funds are
summarized and presented in a single column.
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-8
Ch. 2, Solutions, Case 2-12 (Cont’d)
• Governmental funds are “prepared on a modified accrual basis, which means they
measure only current financial resources and uses.” Capital assets and other long-
lived assets, along with long-term liabilities, are not presented in the
governmental fund statements. However, it should be noted it is stated that “only
• Proprietary funds include both enterprise and internal service funds, prepared on
the accrual basis and include all their assets and liabilities, current and long-term.
b. This is a straightforward way of saying that the governmental fund information
focuses only on current financial resources, not all economic resources. As a result, it
is necessary to present a reconciliation of the governmental fund total fund balances
to the government-wide governmental activities net position and change in fund
General Problem Information: Evaluation of basic financial statements
Learning Objective: 2-3
Topic: Financial Reporting Model
Bloom’s Taxonomy: Evaluate
Accreditation Skills tag: AACSB: Analytical Thinking, AICPA: FN Decision Making
Level of Difficulty: Hard
2-13. There are a variety of reasons for the amounts that have been provided for each fund
balance classification appearing on the governmental fund balance sheet for Denver.
Following are some of the reasons provided in the 2019 CAFR.
Nonspendable sources: The majority of the nonspendable fund balance appears in the
Restricted sources: Most of the functions of the government (General Government,
Public Safety, Public Works, Health, Parks and Recreation, among others) have received
restricted resources. Fund balances are restricted for a variety of reasons having to do
Ch. 2, Solutions, Case 2-13 (Cont’d)
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-9
Committed sources: A number of governmental funds identify committed fund
balances. For the City and County of Denver it is the city council that has the authority to
commit funds through the passing of an ordinance. Most of the committed funds appear
in the General Fund, indicating that most commitments are related to operating activities.
General Problem Information: Major fund criteria
Learning Objective: 2-4
Topic: Fund Reporting
2-14. Depending on when the students are assigned this case, they may have access to the
preliminary views document, exposure draft, or the final standard for the financial
reporting model. As a result, their answers may differ a bit from what is outlined below,
but in general they should identify some or all of the points listed.
• Short-term measurement focus is defined as “a measurement focus that incorporates
elements of financial statements arising from short-term transactions and other events
as they occur and elements of financial statements arising from long-term transactions
and other events when payments are due.” Short-term is intended to be measured as
within one year from the inception of the transaction or other event giving rise to the
transaction.
• Rationales for a new model
o Lack of effectiveness in the current model. There are conceptual inconsistencies
and a general lack of guidance on how to deal with complex transactions.
o Lack of guidance for complex transactions. As governments have entered into
more complicated transactions, the current financial resources measurement focus
has been unable to address how the transactions should be recorded since it is not
based on a conceptual framework.
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-10
Ch. 2, Solutions, Case 2-14 (Cont’d)
o The new short-term measurement focus addresses all of these concerns by clearly
defining the focus and related terms in the context of the conceptual framework.
This will allow future standard-setters a basis for considering how transactions
should be recognized and reported.
General Problem Information: Financial reporting model
Learning Objective: 2-3
Topic: Financial Reporting Model
Solutions to Exercises and Problems
2-15. Each student should have a different government annual report, so each will have
different answers to questions in this exercise. We suggest allowing students to discuss
their answers, which will give them an idea of the range of the answers from other
students.
Bloom’s Taxonomy: Remember
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Easy
2-16. 1. b. 6. a. 11. d.
3. c. 8. c. 13. c.
5. a. 10. b. 15. a.
General Problem Information: Various
Topic: Various chapter topics
Bloom’s Taxonomy: Understand
Accreditation Skills tag: AACSB: Communication, AICPA: BB Industry
Level of Difficulty: Medium
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-11
2. Permanent fund GF
4. Internal service fund PF
5. Pension (and other employee benefit) trust fund FF
6. Special revenue fund GF
8. General Fund GF
10. Capital projects fund GF
11. Private-purpose trust fund FF
Bloom’s Taxonomy: Remember
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Easy
1. Governmental funds c, e, f, h, i
3. Fiduciary funds b, d, g, j
5. Business-type activities, b, g, j
government-wide
General Problem Information: Matching government-wide and fund financial reporting
characteristics
Learning Objective: 2-3
Explanation:
4. Note: Internal service fund information is typically reported in governmental activities using
the same measurement focus and basis of accounting.
2-19.
1.
k.
7.
e.
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-12
2.
b.
8.
i.
3.
j.
9.
f.
4.
d.
10.
5.
g.
11.
h.
6.
a.
General Problem Information: Matching transactions with funds
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Medium
1. d. 6. a.
3. a. 8. d.
5. b. 10. e.
General Problem Information: Fund balance classifications
Learning Objective: 2-4
Topic: Fund Reporting
Bloom’s Taxonomy: Analyze
2-21. DATE: xxx
MEMO TO: City Manager, Forest City
FROM: Independent Auditor
RE: Major Special Revenue Funds
As shown by the blue shading in the following calculations, only the Housing and
Urban Development Grant must be reported as a major fund. Neither the Gas Tax
Revenue Fund nor the Forest City Library Fund meets the GASB threshold for
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-13
Ch. 2, Solutions, Exercise 2-21 (Cont’d)
Calculation of Major Fund Thresholds
Financial
Statement
Elements
Gas Tax Revenue Fund
Housing and Urban
Development Fund
Forest City
Library Fund
>10% of
Govern-
mental
Funds
>5% of
Govern-
mental and
Enterprise
Funds
>10% of
Govern-
mental
Funds
>5% of
Govern-
mental and
Enterprise
Funds
>10% of
Govern-
mental
Funds
>5% of
Govern-
mental and
Enterprise
Funds
Assets
Yes-10.3%
No-4.6%
Yes-11.2%
Yes-5.01%
No-6.5%
No-2.9%
Liabilities
No-8.4%
No-4.9%
No-9.8%
Yes-5.7%
No-0.0%
No-0.0%
Revenues
No-9.0%
No-4.6%
Yes-11.1%
Yes-5.7%
No-7.8%
No-4.0%
Expenditures
No-8.3%
No-8.7%
No-4.9%
No-8.0%
No-4.5%
General Problem Information: Determination of major funds
Learning Objective: 2-4
Topic: Fund Reporting
Bloom’s Taxonomy: Apply
2-22. The students should identify the General Fund as a major fund because it is always
considered a major fund. The only other governmental fund that meets the 10% and the
5% criteria is the Debt Service Fund. It meets the criteria on both expenditures and
revenues. Of the enterprise funds, the Utility Fund and City Airport Fund would be
considered major. The Utility Fund meets the criteria on assets, expenses and revenues,
while the City Airport Fund meets the criteria for all four elements. The following table
Chapter 02 – Principles of Accounting and Financial Reporting for State and Local Governments
2-14
Ch. 2, Solutions, Exercise 2-22 (Cont’d)
* First letter indicates if the 10% criterion is met the second letter indicates if the 5% criterion is
met.
General Problem Information: Determination of major funds
Learning Objective: 2-4
Topic: Fund Reporting
Calculation of Major Fund Thresholds
Assets
Met?
Liabilities
Met?
Expenditures
/Expense
Met?
Revenues
Met?
Governmental Funds
General Fund
462.2
52.8
915.9
992.8
Health & Human Services Fund
110.7
11.9
118.8
NY
125.1
NY
Community Development Fund
220.5
20.9
28.4
NN
16.6
NN
Debt Service Fund
70.8
NN
6.1
NN
132.4
YY
134.7
YY
Total of Governmental Funds by Element
864.2
91.7
1,195.5
1,269.2
10% of Total Governmental Funds by
Element
86.42
9.17
119.55
126.92
Enterprise Funds
Utility Fund
639.4
YY
97.5
NN
104.1
YY
115.9
YY
City Airport Fund
YY
YY
616.7
YY
661.6
YY
Golf Course Fund
48.9
NN
8.6
NN
19.6
NN
18.1
NN
Total of Enterprise Funds by Element
6,107.8
5123.4
740.4
795.6
10% of Total Enterprise Funs by Element
610.78
512.34
74.04
79.56
5% of the Total of Governmental &
Enterprise Funds by Element
348.6
96.795
103.24