After completing this chapter, you should be able to do the following:
No, this is not as complex as the income tax code. The general rules for recognizing revenue and expenditures work most of the time. There are a few exceptions to the rules and, in a few rare cases, exceptions to the exceptions.
Governmental funds use a flow of current financial resources measurement focus and the modified accrual basis of accounting. Under the modified accrual basis of accounting, revenues are recognized when they meet two conditions—measurable and available. Expenditures are recorded when incurred only if the transaction will require the use of current financial resources. This chapter will further explain how revenues and expenditures are recognized and recorded. Certain exceptions to normal recognition rules will also be discussed.
Governmental funds receive revenues from a variety of sources. Typical sources of revenue for a local government include: various types of taxes, fees and fines, licenses and permits, intergovernmental charges for services, and investment earnings. Governments report revenues by major source.
Normally, two of the largest revenue sources for governmental funds are taxes and intergovernmental revenue. Such revenues are not exchange-type transactions and require a different type of recognition criteria. The modified accrual method of accounting for revenues is concerned with when the inflow of financial resources is available to pay for expenditures of the current period.
Under the modified accrual basis, only those revenues that are susceptible to accrual are recognized before the cash is received. To be susceptible to accrual, revenues must be both objectively measurable and available to finance the current period expenditures. Revenues that do not meet these criteria are recorded on a cash basis.
For revenue to be available, it must meet the following criteria:
Consider the following example:
A county levies property taxes of $100,000 for the current year. During the year $92,000 is collected. During the first 60 days of the following year another $5,000 is collected and the balance of $3,000 is collected during the remainder of the year. How should revenue be recorded?
The county would recognize revenue of $97,000 (the $92,000 collected during the year and the $5,000 collected in the first 60 days of the following year). At the end of the current year, the county would report a receivable of $8,000 and deferred inflows of $3,000 (the amount that did not meet the available criteria). In the following year, the county would record the $3,000 as revenue as it is collected.
The available criteria also affect how the allowance for uncollectible accounts is recorded. Because the amount of accounts receivable estimated to be uncollectible will never be available to finance current period expenditures, it should not be recorded as revenue. For example, if taxes in the amount of $100,000 are levied and $2,000 is estimated as uncollectible, the following entry would be made (assume that the $98,000 will be collected during the year).
DR | CR | |
Taxes Receivable | 100,000 | |
Allowance for Uncollectible Accounts |
2,000 | |
Revenue | 98,000 |
In essence, revenues are recorded net of the amount estimated to be uncollectible. If the allowance account needs to be increased or decreased during the year, the adjustment is made to the related revenue.
Revenues of governments are classified as either exchange or exchange-like transactions and nonexchange transactions. Generally the available criteria apply to both types of transactions for governmental funds.
GASB Statement No. 33, Accounting and Financial Reporting for Nonexchange Transaction provides guidance on recognizing both receivables and revenues for nonexchange transactions. Nonexchange transactions are transactions that do not involve an exchange of value. Most taxes and grants fall into this category. GASB has classified nonexchange transactions into four categories:
GASB Statement No. 33 provides guidance on recording revenue for nonexchange transactions under both the accrual method (which would be used by proprietary funds and for all activities reported in the government-wide statement) and for the modified accrual method (which would be used by governmental funds).
The following table summarizes the guidance on reporting nonexchange transactions from GASB Statement No. 33:
Derived Tax Revenues Examples: sales taxes, income taxes, motor fuel taxes Assets Period when underlying exchange has occurred or when resources are received, whichever is first. Revenues Period when underlying exchange has occurred. When modified accrual accounting is used, resources should also be “available.” Report advance receipts as liabilities. Imposed Nonexchange Revenues Examples: property taxes, most fines and forfeitures Assets Period when an enforceable claim has arisen or when resources are received, whichever is first. Revenues Period when resources are required to be used or first period that use is permitted. When modified accrual accounting is used, resources should also be “available.” If resources are received or receivable before the period of use report deferred inflows of resources. Government-Mandated Nonexchange Transactions Examples: federal government mandates on state and local governments Voluntary Nonexchange Transactions Examples: certain grants, entitlements, most donations Assets Period when all eligibility requirements have been met or when resources are received, whichever is first. Revenues Period when all eligibility requirements have been met. Time requirements specify when resources are to be used and are considered an eligibility requirement. Purpose restrictions specify the purpose for which the resources must be used and are not considered an eligibility requirement. Report advance receipts as liabilities. When modified accrual accounting is used, resources should also be “available.” If resources are received before time requirements are met but after eligibility requirements have been met, report deferred inflows of resources.
Classes and Timing of Recognition of Nonexchange Transactions
Class
Recognition
Often a government may share its own derived tax revenues or imposed nonexchange revenues with other governments. For example, a state may share a portion of its sales tax revenue with local governments. In this case, the local government would report this transaction using the guidance for government-mandated and voluntary nonexchange transactions.
2. Which statement is correct regarding nonexchange transactions?
Income on investments should be recorded as revenue when earned. GASB has issued a separate statement on accounting for investments. It generally provides for reporting debt and equity securities at fair value. The change in fair value should be reported as part of investment income. In addition, realized gain and losses should not be reported separate from unrealized gains and losses in the financial statements.
There are two major exceptions to reporting certain debt securities at fair-value, which should be reported at amortized cost:
The issuance of GASB Statement No. 72, Fair Value Measurement and Application, has not changed this exception.
Often, many of the investments purchased by governmental funds are short-term debt instruments that fit the above exceptions and, therefore, are reported at amortized cost.
GASB Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, requires governments to measure most derivative instruments at fair value as assets or liabilities in their accrual-based government-wide, proprietary fund, and fiduciary fund financial statements (but not in the governmental fund financial statements). GASB Statement No. 53 does not address the issue of reporting derivative instruments at fair value in the governmental fund statements. The GASB will reserve consideration of this issue for its conceptual framework project on recognition and measurement attributes.
Governmental funds expend resources for a variety of purposes. Expenditures are reported by character: current, debt service, and capital outlay. Typical current expenditures for a local government include such things as: general government, public safety, public works, health and sanitation, culture and recreation, and community development. Governments should report expenditures by function (general government and public safety) and character (current operations, capital outlay, and debt service). Because governmental funds use the flow of financial resources as a measurement focus, purchase of capital assets and the payment of debt principal are recorded as expenditures.
Generally, expenditures should be recognized in the period in which the fund liability is incurred. In other words, expenditures are recorded when the transaction will require the use of current financial resources. However, there are a few exceptions and modifications to the general rule for recognizing expenditures.
The first exception deals with debt service payments on general long-term liabilities. Governmental entities typically budget resources to meet the current year principal and interest payment requirements. Recording accrued interest at year-end would not be consistent with how these costs are often budgeted. Therefore, expenditures for interest and principal payments should be recorded when they become due.
The exception to the exception: If a government provides resources during the current period to a debt service fund for a debt service payment due early in the next fiscal year (not more than one month), the government may record an expenditure for such interest and principal payment.
A modification to the expenditures recognition is allowed for inventory of material and supplies. In general, the purchase of supplies and material consumes financial resources and should be recorded as an expenditure when purchased. This is known as the purchase method of accounting for inventories.
However, significant amounts of inventories should be reported as an asset even when the purchase method is used. The following year-end adjusting entry for an inventory balance of $25,000 allows for significant amounts of inventory to be reported as both an expenditure and as an asset:
DR |
CR | |
Inventory |
25,000 | |
Nonspendable fund balance |
25,000 |
Because the entry does not adjust expenditures, the full amount of inventory purchased remains reported as an expenditure. Future year-end adjustments for inventory would be made to the same two accounts.
For example, if inventory decreased by $3,000 the next year, a debit to nonspendable fund balance and a credit to inventory for $3,000 would be made.
Governments are also allowed to use the consumption method of accounting for inventories. This method is similar to what a business would use. Expenditures would be reported when materials and supplies are used, not when purchased.
Governments may also use either the purchase or consumption method to report the prepayment of certain costs such as insurance. However, when the purchase method is used for prepaid items, there is no requirement to report significant amounts of prepaid items as an asset.
Governments have adopted the same requirement as businesses to capitalize certain leases that are in essence financing arrangements. In recording a capital lease, both long-term assets and long-term liability are reported in the government-wide statements.
Consider the following example:
A county enters into a capital lease agreement for equipment. The capitalized cost of the equipment is $300,000 and a $25,000 down payment is made at the inception of the lease. The entry to record this transaction in a governmental fund is as follows:
DR | CR | |
Expenditure | 300,000 | |
Other financing source | 275,000 | |
Cash | 25,000 |
Governments may account for lease activities in the general fund or a special revenue fund. They may also account for the inception of the lease in a capital project fund and the lease payments in a debt service fund.
An example of a debt refunding occurs when new debt is issued to retire existing debt. Governments can use the proceeds of the new debt to immediately pay the old debt (current refunding) or place the proceeds with an escrow agent to invest until they are needed to pay the principal and interest of the old debt (advanced refunding).
In advanced refunding, the old debt is considered extinguished, or defeased, if it meets certain criteria. If the debt is considered defeased, the transaction is treated as a retirement of the old debt. If the criteria are not met, then both the old debt and new debt are reported by the government.
For governmental funds, when the proceeds of refunding bonds are used to either redeem existing debt or placed with an escrow agent for the advanced refunding of existent debt, the payment should be reported as an other financing use. Normally debt repayment is reported as an expenditure. However, a debt refunding may distort the normal amount reported for debt service and is therefore reported separately as an other financing use.
Consider the following example:
A county issues new bonds in the amount of $700,000 to advance refund existing debt. The county is required to place in escrow trust $800,000 to service the future debt payments of the existing debt. Entries to record this would be
Sale of bonds | ||
DR | CR | |
Cash | 700,000 | |
Other financing source—refunding bonds issued | 700,000 | |
Payment to escrow agent | ||
DR | CR | |
Expenditure debt service | 100,000 | |
Other financing use—payment to refunded bond escrow agent | ||
700,000 | ||
Cash | 800,000 |
Accrued liabilities for such things as salaries payable are recorded in governmental funds. These liabilities will be paid from available current financial resources of governmental funds. However, there are certain liabilities that are long-term in nature and will not require the use of currently available fund resources. These types of liabilities will not be recorded in the governmental funds until they become due, at which time an expenditure will be recorded.
This treatment applies to the following liabilities:
GASB Statement No. 68 requires the liability of employers to employees for defined benefit pensions (net pension liability) be measured as the portion of the present value of projected benefit payments to be provided through the pension plan to current active and inactive employees attributed to those employees' past periods of service (total pension liability), less the amount of the pension plan's fiduciary net position. This amount is reported in the governmental activities column of the statement of net position. Net pension liabilities should be recognized in governmental funds to the extent the liability is normally expected to be liquidated with expendable available financial resources.
GASB Statement No. 75, Accounting and Financial Reporting for Postemployment Benefits Other than Pensions, was recently issued which will require governments to report a net OPEB liability, similar to the net pension liability, in the government-wide statements. The statement will be effective for periods beginning after June 30, 2017.
GASB Statement No. 47 generally requires governments to recognize a liability and expense for voluntary termination benefits when an offer is accepted and the amount can be estimated. A liability and expense should be recognized for involuntary termination benefits when the plan for termination has been approved by those with the authority to commit a government to the plan, the plan has been communicated to the employees, and the amount can be estimated. If a plan of involuntary termination requires that employees render future service in order to receive benefits, the employer should recognize a liability and expense for the portion of involuntary termination benefits that will be provided after completion of future service ratably over the employees' future service period, beginning when the plan otherwise meets the recognition criteria.
In financial statements prepared on the modified accrual basis of accounting, liabilities and expenditures for termination benefits should be recognized to the extent the liabilities are normally expected to be liquidated with expendable available financial resources.
GASB Statement No. 49 excludes pollution prevention or control obligations with respect to current operations. GASB Statement No. 49 identifies the following five specific obligating events that would require a government to estimate the expected pollution remediation costs and to determine whether outlays for those components should be accrued as a liability or, if appropriate, capitalized when goods and services are acquired:
The statement also provides guidance on how and when to measure the liability for pollution remediation costs.
With regard to display in the governmental fund financial statements, for goods and services used for pollution remediation activities, amounts that are normally expected to be liquidated with expendable available financial resources should be recognized as liabilities upon receipt of those goods and services. In the statement of revenues, expenditures, and changes in fund balances, any facilities and equipment acquisitions for pollution remediation activities should be reported as expenditures.
GASB Statement No. 70 requires a government that extends a nonexchange financial guarantee to recognize a liability when qualitative factors and historical data, if any, indicate that it is more likely than not that the government will be required to make a payment on the guarantee. The amount of the liability to be recognized should be the discounted present value of the best estimate of the future outflows related to the guarantee expected to be incurred. When there is no best estimate, but a range of the estimated future outflows can be established, the amount of the liability to be recognized should be the discounted present value of the minimum amount within that range.
With regard to display in the governmental fund financial statements, a liability and expenditure should be recognized for the amounts normally expected to be liquidated with expendable available financial resources when it is more likely than not that the government will be required to make a payment on the guarantee.
3. Which statement is accurate regarding governmental fund expenditures?
Governmental funds use the modified accrual basis of accounting. Revenues are recognized when they are measurable and available to finance the current period. To be available, revenues must be collected in the current period or soon enough thereafter to be used to pay liabilities of the current period and also legally available to finance current period expenditures. Investments in debt and equity securities are reported at fair value unless they fall into one of two categories that use the amortized cost method.
Generally, expenditures should be recognized in the period in which the fund liability is incurred. However, there are a few exceptions and modifications to the general rule for recognizing expenditures, such as interest on long-term debt and the reporting on inventories and prepaid items. Certain long-term accrued liabilities are not reported in governmental funds.
Income taxes are an example of which category of nonexchange transactions?
Fines and forfeitures are an example of which category of nonexchange transactions?
Under the modified accrual basis of accounting, revenues are considered susceptible to accrual if they are which of the following?
A city levies property taxes of $100,000, 1 percent of which are expected to prove uncollectible. The city should record this transaction as which of the following?
The county received a restricted grant from the state government to be used to train police officers. The county has met all eligibility requirements of the grant, but will not expend the money until next fiscal year. In the current year, how should this grant be reported?
Which investment must be reported at fair value?
A county debt service fund made principal payments of $200,000 and interest payments of $150,000 during the year. The accrued interest on the long-term debt was $10,000 at the beginning of the year and $12,000 at the end of the year. The Debt Service Fund should report which of the following as expenditures for debt service for the year?
The purchases method of accounting is permitted for which expense or expenditure type?