Chapter 9

1. Chapter 9 Business-Type (Proprietary) Activities Granof-5e

2. Thought to Ponder: Chapter 9 "Nobody wants a landfill sited anywhere near them, including in rural areas. We've come to this realization that landfill is valuable and we can't bury things that don't need to be buried." - JON D. JOHNSTON of the EPA, who is helping to lead the zero-waste movement in the Southeast.   NY TIMES-Oct. 20, 2009 Granof-5e

3. Learning Objectives • Why governments and NFPs engage in business-type activities • Distinguish between Proprietary and Governmental activities • Proprietary Fund Accounting • Two types of Proprietary Funds --Enterprise Funds --Internal Service Funds • Accounting for Insurance Activities • GASB 34, special problems of reporting proprietary funds in government-wide statements Granof-5e

4. Proprietary Funds Reasons for use: • to account for governmental entity’s ongoing (continuing) operations and activities • Enhances management of activities in which goods or services are provided on a cost-reimbursement basis (i.e. on a user charge basis.) • To compare benefits and costs of the business-type activities of a government. • Facilitates comparisons with private enterprises Granof-5e

5. Proprietary Funds Two types Proprietary Funds A) Enterprise funds: • Provide services to the general public. • Example: City of Houston’s Airports (Bush, Hobby and Ellington Field), George R. Brown Convention Center, Combined Utility System (formerly called the water and sewer system), etc. B) Internal service funds: • Provide services to other government departments. • Example: City of Houston Health Benefit and Long-term Disability funds. • Both of these services predominantly benefit governmental units rather than the general public or businesses Granof-5e

6. Proprietary Funds -Accounting Characteristics GASB Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting • Funds are said to be nonexpendable (or revolving) • focus on determining operating net income, changes in net assets (or cost recovery). • Full accrual basis • Measurement focus on all economic resources is consistent with GASB • Recognize revenues as earned and expenses as incurred. • Balance sheet recognition to both capital assets and long-term debt. Granof-5e

7. Proprietary FundsRequired Financial Statements Similar to those for a for-profit entity: • Statement of Net Assets (or Balance Sheet): Assets – Liabilities = Net Assets --Three categories of Net Assets 1) Invested in capital assets, net of related debt 2) Restricted Net assets 3) Unrestricted Net Assets • Statement of Revenues, Expenses, and changes in Fund Net Assets: --Reconciles beginning and ending net assets • Statement of Cash Flows --Prepared in conformity with GASB standardsrather than FASB standards --Include cash and cash equivalents (i.e., time deposits, marketable securities, and other items readily convertible to cash) Granof-5e

8. Proprietary Funds - Accounting Equation Assets - Liabilities = Net Assets Recall this is the same classification of net assets that is required under GASB 34. 1) Unrestricted Assets 2) RestrictedAssets (e.g., for payment of debt service) 3) Invested in Capital Assets, Net of Related Debt Granof-5e

9. 2) Restricted Assets • Definition: Assets whose use is restricted by contractual agreements or legal requirements • Typical examples: • Customer deposits of utilities, assets set aside for repayment of revenue bond principal, reserves for maintenance of plant, and funding of depreciation • Ideally liabilities to be paid from restricted assets should be reported separately from liabilities to be paid from unrestricted assets. • Net Assets – Restricted, should be reported in the Equity section of the Statement of Net Assets. Granof-5e

10. Statement of Cash Flows Required for proprietary funds but not governmental funds FASB (NFPs & publicly-traded companies) vs. GASB (Governmental entities): FASB Statement No. 95 classifies cash transactions into: • Cash flows from operating activities • Cash flows from financing activities • Cash flows from investing activities GASB Statement No. 9: • Cash flows from operating activities • Cash flows from NON-CAPITALfinancing activities • Cash flows from CAPITAL & RELATEDfinancing activities • Cash flows from investing activities Granof-5e

11. Enterprise Funds • Accounts for services: 1) provided to the general public on a user charge basis OR 2) where the governing body has determined that periodic determination of revenues earned, expenses incurred, and/or net income is appropriate. • Possible reasons for use: --Capital maintenance, Public policy, Management control, Accountability Examples: The City of Atlanta has two major and four non-major enterprise funds. The City of New York has no enterprise funds, but has a large number of specially created public benefit corporations. On the other hand, High Point, North Carolina has six enterprise funds, and City of San Francisco has eight enterprise funds. Granof-5e

12. Common Types of Enterprise Funds • Water and sewer (public utilities) • Gas and electric utilities • Mass Transportation systems • Airports (ex. Bush, Hobby, Ellington Field) • Ports • Toll roads and bridges (Sam Houston Tollway – Beltway 8, Harris Cty) • Parking garages and lots (ex. Theater District parking garage) • Golf courses (Hermann Park) • Landfill facilities • Hospitals • Liquor stores • Lotteries Granof-5e

13. Accounting for Enterprise Funds GASB Statement No. 34 provides guidance on business-type activities. • MUST use enterprise funds if one of the following criteria is met: • 1) Activity financed solely with revenue debt instead of governmental obligation debt. • 2) Costs of providing services recovered by fees and charges • 3) Pricing policy are designed to recover costs from fees and charges • Previously, GASB standards allowed proprietary funds two options: • 1) Follow pronouncements of the FASB and its predecessors issued before November 30, 1989, unless they conflict with a GASB standard* • 2) Follow all FASB and predecessor standards, both those issued before and after November 30, 1989, unless they conflict with a GASB standard * • *Note that GASB standards always take priority Granof-5e

14. Enterprise FundsUtility Plant - Construction in Progress Q: Should an imputed amount equivalent to interest be capitalized if a utility’s own funds are used for construction? A:Capitalizing an “equity” component of Allowance for Funds Used During Construction (AFUDC) is permitted both by utility regulators and the FASB. Granof-5e

15. Municipal Solid Waste Landfills Accounted for either in governmental or enterprise funds • If usage fees are charged then accounted for in enterprise funds. • Fees must cover ALL costs (i.e. costs incurred before, during, and after landfill accepts waste) • Closure & Post-closurecosts include: • Equipment installed and facilities constructed after the landfill stops accepting waste (e.g. gas monitoring systems, ground water monitoring wells.) • Final Cover • Monitoring & Maintenance • If accounted for in ENTERPRISE FUND: • Governments must report (but need not actually fund) both : • Expense & • Liability related to Closure & Post-Closure costs. • If accounted for in GOVERNMENTAL FUND: • Liability/Expense of post closure costs reported only in government-wide statements. • No expenditure shown in Fund Statements --“Pay-as-you-go” basis Granof-5e

16. Municipal Solid Waste Landfills • An EPA rule requires all municipal landfills to meet stringent location, design, and operating requirements to minimize the potential for environmental damage. • Operators must also provide financial assurance they can properly close landfills when full and provide post-closure ground water monitoring for 30 years after closure. • These stringent rules are designed to protect the environment from irresponsible handling of hazardous materials • Owners must estimate the current cost of hiring a qualified third-party to close the MSWLF and care for it for 30 years after closure • Current Year Liability/Expense = (Estimated total cost x Landfill capacity) ________________________________ - Amount recognized in the past Total Landfill Capacity • Annual adjustments are made as estimates change from year to year. Granof-5e

17. POLLUTION REMEDIATION COSTS Government can be held accountable for pollution cleanup costs owing to a variety of circumstances. For example: • A school district discovered mold or asbestos in one of its buildings • Toxic substances from an abandoned county dump seeped into a nearby water supply As with landfill costs, pollution remediation costs may be accounted for in either governmental or enterprise funds. • Governmental funds: only current outlays would be recognized as expenditures; no long-term liabilities would be recorded. • Enterprise funds as well as government-wide stmts: estimates of costs to be incurred in the future would be reported as both expenses and offsetting liabilities. Granof-5e

18. POLLUTION REMEDIATION COSTS (Cont’d) Per GASB Statement No. 49 Accounting and Financial Reporting for Pollution Remediation Obligations (November 2006), the pollution remediation costs to be accounted for include those for: • Pre-cleanup activities such as site assessments, site investigations, • Cleanup activities such as removal and disposal of pollutants • Government oversight and enforcement-related activities • Post-remediation monitoring These costs should be estimated and recognized as an expense and liability when the government knows or has reason to believe that a site is polluted, that it will be responsible for the cleanup, and it can make reasonable estimates of the ultimate cost. Granof-5e

19. Enterprise FundsSpecial Current Liabilities In addition to the usual Accounts Payable and Accrued Expenses, use two special current liability accounts: 1) Customers Advances for Construction • Usually up-front deposits required to be made by builders to provide all or part of the cost of connecting new structures to utility lines. May or may not be refunded in part upon completion 2) Customer Deposits • Usually reported under the caption “Liabilities Payable from Restricted Assets” Granof-5e

20. Enterprise FundsRegulatory Accounting Principles (RAP) FASB Statement No. 71 Accounting for the Effects of Certain Types of Regulation issued in 1982, stipulated that revenues, expenses and resources should be recognized in accordance with the rules established by a regulator. Key RAP definitions • Original cost: The (depreciated) cost to the first owner to place the utility plant into public use • Utility Plant Acquisition Adjustment: The difference between the purchase price of a utility plant less the net original cost of the plant on the seller’s books. Granof-5e

21. Enterprise Funds Segment Information When there are multiple enterprise funds • Summary operating data, including extent of intra- governmental subsidies, should be disclosed in the notes for "major non-homogeneous enterprise funds." Granof-5e

22. Internal Service Funds Internal Service funds are an accounting device used to accumulate and allocate costs internally among the governmental entity’s various departments/units/functions. Account for activities: -- that provide goods or services to other funds, departments, or agencies within the same governmental unit or occasionally to other governmental units on a user-charge or cost-reimbursement basis Primary reason for use:--to gain efficiency in the government’s operations. Examples: The City of Houston has two internal service funds; San Francisco has four internal service funds (central shops fund, finance, corporation reproduction fund, telecommunications and information fund) whereas the City of New York has no internal service funds. Granof-5e

23. Common Types of Internal Service Funds • Motor pools • Central purchasing • Storage • Issuance of supplies • Self-insurance pools • Central data processing • Printing Granof-5e

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26. Accounting for Internal Service Funds Internal Service Funds . . . • . . . are accounting entities • . . . are authorized by legislative approval • . . . rarely have its resources restricted • Must follow all FASB pronouncements issued prior to Nov. 30th 1989 unless it conflicts with GASB pronouncement (like enterprise fund). • The GFOA recommends that every state or local government establish clear criteria for whether an internal fund is classified as a fund in the CAFR. Granof-5e

27. Accounting for Internal Service Funds (cont.) Accounting: • Full Accrual Basis --Revenues derived mainly from other governmental or proprietary funds. --“Billings to Departments” is the revenue account that is similar to “Sales” of a for-profit. --Capital assets acquired by contributions or grants must be depreciated. • Revenues & expenses are closed at year-end to “Excess of Net Billings to Departments over Costs” (or “Excess of Costs over Net Billings to Departments”) rather than to Income Summary • Since the only “customer” of the internal service fund is the government itself, the activity is presented in fund financial statements, but eliminated for external facing reporting. • The major fund requirements do not apply to internal service funds because their balances are eliminated in the government-wide financial statements Granof-5e

28. Pricing Policies for Internal Service Funds • Pricing is set by local management or by legislative policy • Pricing objectives vary --Can cover full costs (direct and indirect), direct costs only, or whatever management desires. --Full cost prices do not reflect cost of providing incremental amounts of goods or services. Granof-5e

29. Question Number One (1) Q: Assume that one of the government’s internal service funds was for data processing services, for which the golf course was billed $30,000, all of which was classified as “contractual services” in the golf course fund. How would that amount be reported in the column for ISF? How would it be reported in the government-wide financial statements? A: Fund Statements: Billings of ISF would be reported as a revenue of ISF and as an expense of the golf course. The related cost of providing the service would be reported as an expense of the ISF. Government-wide: Billings would be reported ONLY as an expense of the golf course. The revenues and expenses of the ISF would be eliminated in the consolidation process. Granof-5e

30. Pregunta Número Dos (2) Q: ISF reported $2.7 million in depreciation, an amount that the government takes into account in establishing the rates charged to other funds. How would this charge be reflected in the government-wide statements? A: The depreciation charges are incorporated into the amounts billed to the funds to which the ISF provide services. Therefore, in the government-wide, they would be incorporated into the expenses of the functions accounted for in those funds. Granof-5e

31. вопрос, номер три (3) Q: In which column on the government-wide statement of net assets—that for governmental or business-type activities—is it most likely that the assets and liabilities of the ISF would be included? A: Unless the ISF provides services mainly to units accounted for in proprietary funds, their assets and liabilities would be reported in the column for governmental-type activities. Granof-5e

32. 问题第四 (4) Legislative bodies are sometimes reluctant to establish ISFs because they do not wish to let purchasing occur outside the budget. Q: Is this (budget) a real concern? A: Even if an ISF is created for central purchasing and sales of supplies, the legislative body still maintains budgetary control over the expenditures made by most departments and programs via the General Fund and special revenues funds budgets. Granof-5e

33. Self-Insurance • Some governments elect to self-insure their risks. --Reduces premiums • Self insurance = NO INSURANCE (no transfer of risks to outsider.) --It simply sets aside funds to provide for possible losses based on an actuarially determined amount. --Often a govt. that self-insures part (or all) of its risk also centralizes its risk financing activities --Either use the GF or the ISF to account for these activities Example: City of Juneau, Alaska has a self-insurance fund to account for the cost of administering the City and Borough’s Risk Management Program. Granof-5e

34. Self - Insurance GASB-mandated use of an ISF • GASB standards require that an ISF be used for risk management (self-insurance) pools of a government: --The ISF should recognize claims expense and a related liability when: 1) It is probable an asset has been impaired, a liability incurred, or a claim will be asserted AND 2) Loss is estimable Disclose other loss contingencies in the notes. • Insurance department acts as an independent insurance company. • Premium Payments by government to ISF: • Only a portion is reported as expenditureby the government (and revenue by the ISF). • Excessis a nonreciprocal transfer. Granof-5e

35. PROBLEMS with ISFs • Duplicate reported expenses when closing books -costs and revenues are reported twice within the same set of financial statements. • Depreciation is transferred to other governmental funds • Detract from Objectivity of Financial Statements • Obscure Fund Balance Surpluses or Deficits -surpluses/deficits can be transferred from general fund to the internal service fund. Granof-5e

36. Terminating an Internal Service Fund • Transfer ISF's assets to another fund which will continue same activity • Terminate activity and distribute assets in-kind to another fund or funds • Convert ISF's assets to cash and distribute cash to another fund or funds Granof-5e

37. Component Units (CU) • The main reason for discussing CU in Ch. 9 is that some cities will carry out these activities as CU and some will do it as part of EFs. The main difference is the legal structure. CU are separate legal entities. • Entities that are economically intertwined with the government albeit legally separate • Criteria to determine whether a primary government (PG) is financially accountable for another government. (1) PG appoints a voting majority of unit’s governing body (2) A majority of unit’s governing body is composed of PG’s officials (3) The PG is able to “impose its will” upon the unit (4) Unit can cause the PG financial benefits or burdens • If it meets these criterion, then unit is a CU of PG. • Two Presentations of CU (1) Blended – CU consolidated with PG in government-wide statements • Presented this way if CU “provides services exclusively or almost exclusively for the city” (City of Houston CAFR) (2) Discrete – CU shown in a separate column in government-wide statements Granof-5e

38. Business –Type ActivitiesSummary • Proprietary funds (internal service and enterprise) are used to account for the business-type activities of a government • Accrual accounting is used for proprietary funds and the required financial statements are the same as those for a for-profit entity, except that GASB standards must be used where they apply • ISF are reported as governmental activities on the government-wide statements • Regulatory accounting terminology and principles are used by some government owned utilities. Granof-5e