Essentials of Accounting for Governmental and Not-for-Profit Organizations

Essentials of Accounting for Governmental and Not-for-Profit Organizations Chapter 5: Accounting for Other Government Funds -- Capital Projects, Debt Service and Permanent

Overview of Chapter 5 • Review of common characteristics of governmental type funds • Capital Projects Funds • Debt Service Funds • Permanent Fund • Review of Fund statements—Government type funds

Review of Government Type Funds • Use modified accrual basis • Long-term asset purchases treated as expenditures, no depreciation • Generally do not carry long-term assets or long-term liabilities on fund balance sheet • If annual budget is used, may be recorded in fund • If control of purchase orders is relevant to the fund, can use encumbrance accounting

Capital Project Funds • Used for construction or acquisition of major long-term assets such as buildings, bridges, etc. for government funds • Proprietary type funds handle construction activities in proprietary fund, not capital project fund • Accounts for issuance of bonds and receipt of other financing sources • Accounts for construction or acquisition expenditures • Does not carry the long-term asset in the CP fund—Treated as expenditure in the fund • Long-term asset is listed in entity-wide Statement of Net Assets

Primary Sources of Funds for Capital Projects • Issuance of bonds • Grants from other government units • Transfers from other funds • Donations • Interest earned on funds held

Number of CP Funds to Use • Some jurisdictions may require separate CP for each building project • Otherwise, may account for all, or at least related construction projects, in a single fund using the ‘fund within a fund’ approach • Separate accounts for Expenditures - Project 1, Expenditures - Project 2, etc. • General rule—make sure you can prove funds intended to be used on a specific project are traceable to the project

Capital Projects and the “Life Cycle” Concept • For capital projects the “life cycle”—time from start to finish—is perhaps even more important than the annual budget year • Accounting records must show the cost of the entire project over its entire building cycle, even if that extends over two or more fiscal periods • This may require special closing procedures to make sure last year’s expenditures are not lost

Common Entries in CP Fund • Note text does not show budget entry • Budget entry is used IF, the SLG decides to prepare an annual budget. • The budget is often prepared on the life cycle time frame for the whole project; may be no attempt to subdivide project by year due to unpredictability of weather etc. • Entry #1, BANs, bond anticipation notes prior to issuance of bonds • Entry #2, recording receipt or authorization of transfers and grants • Entries #3 and 4 are optional in CP fund—may want to use encumbrances if handling details of ordering—if contractor will do this, may not record encumbrances

Common Entries in CP Fund • #5, 6, and 7—recording encumbered and unencumbered expenditures and receipt of accrued resources • #8—Issuance of bonds • Bond Proceeds is an Other Financing Source • Not listed as a liability in CP fund, will be listed in entity-wide Statement of Net Assets • #9 Repayment of BANs and interest

Common Entries in CP Fund • #10 Contract payment and retained % • SLGs are typically required by law to retain a certain percentage of each progress payment; this will not be released until the job is completed to the government’s satisfaction • If the contractor balks at making requested corrections, the SLG can have another company make corrections and charge the cost against the Retained % • Entries #11 and 12 and 14 show reversal of encumbrances as additional expenditures are incurred

Common Entries in CP fund • #13—receipt of cash on receivable previously accrued from other governments • #15—final payment on contract, including release of retainage • #16—any remaining cash left in CP at the end of its life cycle is moved to another fund … law may require movement to Debt Service or General Fund • #17—the closing entry closes all revenues, expenditures, other financing sources, other financing uses, and encumbrances (if any)

Closing Issues If Life Cycle Spans More Than One Fiscal Year • To close the books in the normal fashion will zero out prior year expenditures • May need to a keep running total of expenditures from start to finish of project • Two choices on how to modify closing approach: • Use a worksheet to calculate the effect of closing entries, but do not close CP fund until end of the project • Do close CP books, but re-enter previous year’s total balances as beginning balance of revenues, expenditures, other financing, etc. for the next year

Lease Accounting for SLGs • Operating leases—true rental situation • Capital leases—these are ‘in-substance’ purchases of long-term assets on time with interest • Criteria to be treated as capital lease are same as for businesses • Transfers ownership • Contains bargain purchase option • Life greater than 75% of asset’s life • Present value of minimum lease payments greater than 90% of fair value of asset

Lease Issues Cont’d • At the inception (beginning) of the lease, the present value is recorded as follows: • Expenditure XX = PV of payments • Other Fin. Source - Lease XX = PV of payments • The Expenditure dr. shows the equivalent of an asset purchase, and the OFS cr. shows the equivalent of issuing a long-term note • At the inception of the lease the PV of lease payments is recorded as the value of the asset and of the liability in the entity-wide statements • Over time, the net asset value in the entity wide stmt of net assets is decreased by its accumulated depreciation • Over time, the liability is decreased by the amount of the principal portion included in each lease payment

Special Assessments • “Special” Assessments are similar to property tax payments, but the payer receives direct benefits • Citizens in a limited area may vote or petition the government to provide and charge them for these benefits • Two types • Service type • Construction type

Special Assessment Types • Service type: • Example, county residents want same police protection as citizens in town and are willing to pay for it through extra assessments • Construction type: • Example, residents want their street paved and are willing to have the cost charged to them over a period of time

Accounting for Service Assessments • The SLG will use whatever fund they normally use for that service to record the assessment revenue • For example, if the assessment is for extra policing and police costs are in the general fund, then the assessments will be treated as general fund revenues • If the assessment were for service normally accounted for in a special revenue or enterprise fund, then use those funds

Accounting for Construction Assessments • Accounting is different for the following two scenarios: • The government unit is primarily or secondarily liable to pay off the special assessment construction loan in the event that taxpayer revenues are insufficient • The government will NOT hold itself liable, either legally or by choice, in the event that taxpayer payments are insufficient to pay the debt • Default might happen in the event of a severe economic downturn, major local employer leaves, or if for some reason the citizens refuse to pay as a form of political protest

Construction Special Assessment Issues • Government liable on the debt • Record construction in CP fund as usual • Record repayment of debt in DS fund as usual • List assets constructed and the special assessment debt in the entity-wide statement of Net Assets • IN OTHER WORDS…SAME AS ANY OTHER CONSTRUCTION PROJECT

Construction Special Assessment Issues Cont’d • Government not liable on debt • Debt/bonds not listed in entity wide stmt of Net Assets since it not an obligation of SLG • Collections of assessments from taxpayers and remittance to bondholders handled in agency fund • Text says CP fund not involved, but may depend on circumstances: • CP may be used for construction phase • Constructed infrastructure assets may be listed in Entity-wide statement of Net Assets if SLG responsible for upkeep

Purpose of Debt Service Fund • The debt service fund accumulates resources to pay debt principal and interest on long-term debts of the overall government • DS fund is not used for proprietary fund debts, those funds carry their own long-term debt • While the debt service accumulates money and makes principal and interest payments, bonds payable is not a liability of the DS fund because the DSF uses the modified accrual basis/flow of current resources approach • The Bond Liability is in the entity-wide statement of Net Assets

Sources of DS Financing • Taxes earmarked for debt service • Transfers from general fund • Special assessments when government is liable on debt • Premiums or accrued interest on bond issuance are often transfer to DSF from Capital Project fund (CPF) • Refinancing bond proceeds • Residual equity transferred from CPF

Modified Accrual Basis & DSF • Exception to expenditure portion of modified accrual definition • Most expenditures are recorded when the liability is incurred • EXCEPT for interest and principal which is record in the DSF as an expenditure when DUE • But, there is an exception to the exception: • Example: When year ends December 31, 20X1 bond payments is due January 1, 20X2 ( or within a month), and the money for the payment was provided in the 20X1 budget—then an expenditure and liability for the upcoming payment may be recorded in fiscal year 20X1 • Key issue—put expenditure in the year it was budgeted

Uses of Debt Service Funds • Sinking fund and payments on term bonds • May use them for serial bond payments, or can be handled in general fund • Payments on long-term notes • Payments on capital lease (but could be in GF) • How many debt service funds? • Use good sense—using ‘fund within a fund approach’ may help reduce record keeping by combining some debts into a single DSF

Common Entries for DSFs • Note text does not illustrate budget entry—this is optional. Bond transactions generally planned over entire ‘life cycle’ of bond with amortization table—this serves to control the fund at least as well as budget entries • Entry #1 assumes the capital project fund was required to remit premium to the DSF—if not required by law, this might be credited to Operating Transfer • Entries #2 and #7 shows receipt of Operating Transfers • Entries #3-6 show the use of a fiscal agent to help with the actual distribution of bond principal and interest payments • Because bonds are constantly traded, an external fiscal agent is more efficient than the SLG having to keep up with the names and addresses of persons receiving interest checks

DSF Closing Entry • Entry 8 shows closing process • No need to reverse budget entry, since not used • Typically DSFs have no need for encumbrance accounting, therefore no encumbrances to close out • This particular illustration did not have any Revenues or Other Financing Uses. These would be closed if used by the fund.

DSF Accounting Variations • For serial bonds, money is moved in, payments made, and little or no balance exists at year end • Because of this simplicity, some governments may actually handle Debt service in General Fund if allowed by law • Term bonds: All the principal of the bond comes due at end of the term (perhaps after 30 years), interest may be paid over time, or all at the end as well • Deferred serial bonds: these may not start the payments for 2 to 5 years after the bonds are used • Allows time for property taxes to begin coming in before payments start

DSF Variations cont’d • In term bond and deferred serial bond situations, the DSF acts as a sinking fund.= • Money is moved into the fund and invested in revenue generating investments • Present value techniques and amortization tables are used to plan the amount of money that must be invested so that original money plus revenue earned over time equals required bond principal and interest payments • After all interest and principal payments are made, any excess money will be transferred out—probably to General Fund—and the fund will be closed/terminated

DSF and Lease Payments • Debt Service Funds commonly used for capital lease payments, though General Fund may sometimes be used • In DSFs both the payment of principal and payment of interest results in an EXPENDITURE • However, should keep the amounts separate, • Because only the principal portion reduces the net liability on the entity wide Statement of Net Assets • Entry page 132 • Interest = effective rate X remaining liability balance • Principal = plug figure

Permanent Funds • Permanent fund characteristics: • A principal amount which is to be invested in perpetuity • Earnings in the fund can be spent for purposes that benefit the government or its citizens • Example: Perpetual cemetery fund set up by citizen donation

Common Entries in Permanent Funds • Note: Budget entry not illustrated. Can record budget, but not required • #1: Initial contribution from citizen is treated as a revenue • #2 and 3: Purchase of investments; interest earnings • #4: Use of earnings to make allowed expenditures

Permanent Fund Entries cont’d • Entries #5-7 show end of period adjustments and closing process • #5: Interest or dividend revenue is accrued • Interest expenditure is not accrued until due, but interest revenue is accrued • #6: GASB #31 requires an adjustment to FAIR VALUE for most types of investments • Business approach of trading/available for sale/held to maturity classifications of investments is not used • #7: Note Fund balance will be listed as restricted on fund and entity-wide statements • FYI: Same approach illustrated here for Perm. Fund would be used for Debt Service Sinking Fund Investments

Review of Fund Financial Statements for Government Type Funds • Balance Sheet for all Government funds • Must list General Fund, Major Funds, and single column for nonmajor funds • This illustration shows all the funds, even though the Fire Station Addition Debt Service does not appear to meet the 10% or 5% criteria on page 134 • Okay to show nonmajor funds separately if does not make the reports too cumbersome • Note: Fund Balance shows Reserved and Unreserved

Review of Fund Financial Statements for Government Type Funds Cont’d • Statement of Revenues, Expenditures, and Changes in Fund Balance pages 136-137 • Will have columns for same GF, Major, and Nonmajor funds used in Balance Sheet • Format: • Revenues - Expenditures • + or - Other Finance Sources/Uses • + or - Special Items • = Change in Fund Balance • + Beginning Bal = Ending Fund Balance • Note Character Classifications of Expenditures—Current, Debt Service, Capital Outlay

Slides prepared by • Dr. Louella Moore • Arkansas State University

Essentials of Accounting for Governmental and Not-for-Profit Organizations