After completing this chapter, you should be able to do the following:
Governments are required to include certain minimum information in their external financial reports. The requirements are designed to meet the basic needs of a broad group of external users. A government's general purpose external financial statements contain, at a minimum, the following items: management's discussion and analysis, basic financial statements, and required supplementary information.
The financial statements for governments include both fund-based and government-wide statements. GAAP requires that the general purpose external financial statements contain at a minimum, the following:
— Government-Wide Financial Statements
— Fund Financial Statements
— Notes to the Financial Statements
The relationship of the different elements that are required for general purpose financial statements can be seen in the following chart. This chapter discusses the fund financial statements.
A government may have three different types of funds: governmental, proprietary, and fiduciary These fund types have different operating objectives and use different measurement focuses and bases of accounting. In essence, they measure and report financial activity differently. As a result of this, each fund type will have its own set of financial statements.
MD&A should be presented before the basic financial statements and is part of RSI that must be presented in the financial statements (the nature of RSI is discussed in the next section).
MD&A provides an objective and easily readable analysis of the government's financial activity for the year. This is written by management and highlights events important to the readers.
It is based on currently known facts, decisions, and conditions and must discuss both positive and negative aspects of the current year activity.
MD&A comprises up to eight separate elements, depending on the government, as follows:
— The MD&A should focus on the activities of the primary government. The decision to include comments about a government's component units is a matter of professional judgment and should be based on the significance and relationship of the component unit with the primary government. Any information presented for a component unit should be clearly distinguished from that of the primary government.
— The MD&A includes a discussion on the basic financial statements and the relationship between government-wide statements and fund financial statements. This discussion enables readers to understand the differences between financial results reported in the two sets of financial statements.
— The MD&A should discuss current year results in comparison with the prior year. This is the only place in the general purpose external financial reports where governments are required to present comparative information.
— The MD&A discusses the overall financial position and results of operations for the government. This analysis provides reasons that explain why the financial position of the government has either increased or decreased for the year. The analysis should also address the financial activities of both governmental and business-type activities as reported in the government-wide statements.
— The MD&A also addresses any significant changes in the fund balances or fund net position for the year, and it provides comments on any significant restrictions or commitments affecting the availability of fund resources at the end of the year.
— The MD&A also should provide an analysis of any significant variation between the original budget and final budget and between the final budget and actual budget results for the general fund.
— A description of significant capital asset and long-term debt activities is also included in the MD&A. This discussion should include any significant commitments, changes in credit ratings, debt limitations that may affect the financing of planned facilities or services, and new debt issuances.
— If a government is using the modified approach for certain infrastructure capital assets, the MD&A should discuss any significant changes in assessed condition of eligible infrastructure, how the current assessed condition compares with the level set by the government, and any significant differences in the amount spent to maintain infrastructure from the annual amount estimated to maintain those assets.
— The MD&A also includes a description on any currently known facts, decisions, or conditions that are expected to have a significant financial effect on the government. Currently known facts would include any items that occurred after year-end but before the date of the auditors' report.
Governments are also encouraged to use charts, graphs, and tables in the MD&A to enhance the understandability of the information.
— Examples could include the following:
o Changes in tax rates, tax base, or population
o Loss of significant employers
o Settlement of significant lawsuits
o New labor contracts
o Deficit reduction measures.
Governments must also provide condensed financial information (from the government-wide statements) comparing the current year with the prior year. Governments are required to report the following condensed financial information:
Required Condensed Government-Wide Financial Information |
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1. Which statement is accurate regarding MD&A?
RSI (including MD&A) is information that a government must present as part of its financial presentation, but is unaudited.
Auditors are required to perform certain limited procedures on RSI to include the following:
However, the absence of, or deficiencies in, RSI does not affect the auditor's opinion on the financial statements. In such cases, the auditor adds information to the audit opinion describing the situation.
As stated earlier, the MD&A is presented before the basic financial statements. Other RSI is presented after the basic financial statements. Governments may be required to report the following additional items as part of RSI:
— General fund
— Each major special revenue fund with a legally adopted annual budget.
Governments have the option of including these schedules as part of the fund financial statements as opposed to reporting them as part of RSI.
These schedules must contain a minimum of three columns for each governmental fund reported: original budget, final budget, and actual amounts reported using the budgetary basis of accounting. A variance column may be included to facilitate the comparison of budget and actual amounts, but is not required. The budget comparison schedule can be prepared using the same format and terminology of the budget document or using the same format as the statement of revenues, expenditures, and changes in fund balances.
Additional information must be provided about the basis for the condition measurement and the scale used to assess and report condition. The condition level the government intends to preserve the infrastructure assets must also be disclosed. Factors that significantly affect trends in the information reported in the required schedules must be disclosed.
— GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions (amended by GASB Statement No. 63); will be completely superseded upon the effective date of GASB Statement No. 75
— GASB Statement No. 67, Financial Reporting for Pension Plans (an amendment of GASB Statement No. 25)
— GASB Statement No. 68, Accounting and Financial Reporting for Pensions (an amendment of GASB Statement No. 27)
— GASB Statement No. 73, Accounting and Financial Reporting for Pensions and Related Assets That Are Not within the Scope of GASB Statement 68, and Amendments to Certain Provisions of GASB Statements 67 and 68 — Effective for periods beginning after June 15, 2016
— GASB Statement No. 74, Financial Reporting for Postemployment Benefit Plans Other than Pension Plans — Effective for periods beginning after June 15, 2016
— GASB Statement No.75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions — Effective for periods beginning after June 15, 2017
2. Which statement is accurate regarding RSI?
The fund financial statements provide important information on how the separate parts (funds) of a government did for the year. How much was received, spent, and what is left over for a particular purpose can best be determined with fund financial statements. These statements are additionally used to determine compliance with finance-related laws, rules, and regulations. Through the budget process, governments often make resource allocation decisions by fund. To demonstrate accountability, governments must provide financial information by funds.
The number of individual funds a government may have can vary from just a few to several dozen. Generally, a government should have the minimum number of funds necessary for sound financial management and/or to meet legal and accounting requirements. It takes more funds for some governments than others to meet this requirement.
Should information for each fund be reported in the basic financial statements? This could be done, but the reports may become quite long. An alternative may be to report information by fund type. However, information about individual funds would be lost. A final alternative (and the one used) would be to present information about the largest and most important funds separately, and combine the information of the other funds into a single column. The major fund approach allows the user to focus on the most important funds of a government.
Reporting by major funds only applies to governmental funds and enterprise funds. It does not apply to internal service funds or fiduciary funds, which are reported in columns by fund type.
In the governmental and proprietary fund financial statements, governments report separate columns for each major fund. Nonmajor funds as well as internal service funds are combined and reported as single columns in the financial statements.
Now that we understand that reporting is done by major funds, how do we determine which funds are major? First, the general fund is always major. Second, a government can make any governmental or enterprise fund major if the fund is believed to be important to financial statement users.
3. Which statement is accurate regarding major fund reporting?
A government needs to test annually all other governmental and enterprise funds to determine if they are major and must be reported in a separate column. A fund is major if it meets both of the following criteria:
Testing for major funds is a two-step process. Only if an item (such as total revenues) for a fund passes the first test would the second test be done. Also the same item (such as total revenues) must pass both tests.
For example, the first test would compare a special revenue fund's total assets + deferred outflows of resources, liabilities + deferred inflows of resources, revenues, and expenditures with the total for these same items for all governmental funds. If none of these listed items for the special revenue fund should exceed 10 percent of the totals for all governmental funds, the fund would not be considered major and the second test would not be done.
However, if total revenues for the special revenue fund were the only item that passed the 10 percent test, then total revenues of the special revenues fund would be tested to determine if they were at least 5 percent of the total revenues of governmental and enterprise funds combined. If so, the special revenue fund would be major. The same item has to pass both tests.
The major fund tests need to be done each year. A fund may meet the criteria to be major one year and not the next year. So, it is possible that the major funds reported in separate columns in the fund financial statements could be different each year.
For example, a government may have a large capital project one year and none the next year. During the period where there is much activity, the fund could meet the major fund criteria and be reported in a separate column in the fund financial statements. In periods where there is little activity, the fund is combined and reported with other nonmajor funds. However, a government has the option of continuing to report as major any fund it thinks important.
Below is an example major fund calculation for a special revenue fund:
Consider The Following Example for Special Revenue Fund A | |||||
Special Revenue Fund A | All Governmental Funds | All Governmental & Enterprise Funds | 10% Test | 5% Test | |
Total Assets + Deferred Outflows of Resources | $640,000 | $3,200,000 | $5,200,000 | Passed | Passed |
Total Liabilities + Deferred Inflows of Resources | $220,000 | $3,000,000 | $3,500,000 | Failed | Not Applicable |
Total Revenues | $270,000 | $2,500,000 | $6,500,000 | Passed | Failed |
Total Expenditures | $180,000 | $2,400,000 | $4,500,000 | Failed | Not Applicable |
Result: Two items (assets and revenues) passed the 10 percent test. Only these two items would be used for the five percent test. Since total assets passed both tests, Special Revenue Fund A would be reported as a major fund. If the first item passed both the 10 percent and 5 percent test, the special revenue fund would be considered major, and you wouldn't need to test the other items. |
Governmental funds follow the flow of financial resources measurement focus and the modified accrual basis of accounting. The financial statements report what financial resources were received during the year, how they were spent, and what amounts remain at year-end. Capital assets and long-term liabilities are not reported in governmental funds' financial statements.
Governmental funds report two financial statements:
The governmental funds' balance sheet reports the current financial assets, current liabilities, and fund balances. Separate columns are used to report each major fund and a column is used to report nonmajor funds in the aggregate. A total column for all governmental funds is also required.
Governments are required to provide a summary reconciliation of the amount reported in the balance for total governmental fund balance to the amount reported as net position for governmental activities in the statement of net position. The summary reconciliation may be reported at the bottom of the balance sheet or in an accompanying schedule.
The governmental funds' statement of revenues, expenditures, and changes in fund balances reports inflows, outflows, and ending balances of current financial resources. Again, separate columns are used to report each major fund and a column is used to report nonmajor funds in the aggregate. A total column for all governmental funds is also required.
Governments are required to use the following format in the statement of revenues, expenditures, and changes in fund balances:
Format of the Statement of Revenues, Expenditures and Changes in Fund Balances |
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Revenues (detailed) | XX |
Expenditures (detailed) | XX |
Excess (deficiency) of revenues over expenditures | X |
Other financing sources and uses including transfers (detailed) | X |
Special and extraordinary items (detailed) | X |
Net change in fund balances | X |
Fund balances - beginning of period | X |
Fund balances - end of period | X |
A summary reconciliation is also required for the amount reported as change in governmental fund balances to the amount reported as change in net position for governmental activities in the statement of activities. The summary reconciliation again may be reported at the bottom of the statement of revenues, expenditures, and changes in fund balances or in an accompanying schedule.
Governments are also required to report budgetary comparison schedules for the general fund and each major special revenue fund with a legally adopted annual budget. These schedules are normally reported as part of RSI. However, governments may elect to report these schedules as budgetary comparison statements as part of the fund financial statements.
Proprietary funds follow the flow of economic resources measurement focus and the accrual basis of accounting. These funds are used to report a government's business-type activity and follow businesstype accounting. Their financial statements report all assets and liabilities belonging to the funds.
Proprietary funds report three financial statements:
The financial statements report separate columns for each major enterprise fund, a column for nonmajor enterprise funds, and a combined total column for all enterprise funds, followed by a column for the combined total for all internal service funds. The internal service funds are being reported as a fund type and are not combined with the enterprise funds.
Normally, a reconciliation of the proprietary funds' financial statements to the government-wide financial statements is not needed. The totals for net position and changes in net position for the enterprise funds are often the same for net position and changes in net position reported for business-type activities in the government-wide statements. If there are differences, reconciliations should be presented in the fund financial statements or in an accompanying schedule.
Proprietary funds may present either a statement of net position (assets + deferred outflows of resources — liabilities — deferred inflows of resources = net position) or a balance sheet (assets + deferred outflows of resources = liabilities + deferred inflows of resources + net position). While either the statement of net position or the balance sheet presentation is permitted, the statement of net position format is encouraged. The statement should be presented in a classified format, separating current assets (and the current portion of deferrals) and liabilities (and the current portion of deferrals) from long-term assets and liabilities. Net positions are reported in three broad categories: net investment in capital assets; restricted; and unrestricted. Any designations of net position are not reported on the face of the financial statements.
The proprietary fund financial statement, statement of revenues, expenses, and changes in net position, is similar in function, or corresponds to, the operating statement in for-profit reporting. The statement separates operating revenues and expenses from nonoperating revenues and expenses and other items. This format allows the fund to report an amount for operating income (or loss).
Governments need to adopt a policy that defines operating revenues and expenses that is appropriate for the activity. GAAP does not directly provide a definition of what should be classified as operating, but state that how items are classified for the cash flow statement should be considered. The classifications used for the cash flow statements are discussed shortly.
The format of the statement is as follows:
Format of the Statement of Revenues, Expenses, and Changes in Net Position |
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Operating revenues (detailed) | XX |
Operating expenses (detailed) | XX |
Operating income (loss) | X |
Nonoperating revenues and expenses (detailed) | X |
Income before other revenues, expenses, gains, losses, and transfers | X |
Capital contributions, additions to permanent and term endowments, special and extraordinary items and transfers | X |
Increase (decrease) in net position | X |
Net position - beginning of period | X |
Net position - end of period | X |
Proprietary funds report a statement of cash flows under the direct method. The purpose of a statement of cash flows is to provide relevant information about cash receipts and disbursements for the period. The information should assist users in determining the following:
GASB defines four types of cash flows: operating activities, noncapital financing activities, capital and related financing activities, and investing activities. The following table provides a description of what should be included in each category of cash flows.
Cash Flow Categories |
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Cash Flows from Operating Activities Cash flows from providing goods and services and, generally, all cash flows not explained in the other three categories are included in cash flows from operating activities. It includes cash flows from
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Cash Flows from Investing Activities This category of cash flows primarily includes investment activities that are not part of a fund's program and involves investments that are not considered cash equivalents. It includes cash flows from
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Cash Flows from Noncapital Financing Activities Noncapital financing activities primarily include borrowing activities not related to capital assets, and certain interfund and intergovernmental activities not related to capital assets and operating purposes. It includes cash flows from
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Cash Flows from Capital and Related Financing Activities Capital and related financing activities primarily include acquiring and disposing of capital assets. It includes borrowing activities and certain interfund and intergovernmental activities related to capital assets. It includes cash flows from
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Cash flows from operating activities are reported under the direct method using the following minimum classes of receipts and payments:
Proprietary funds must also report a schedule that reconciles cash flows from operating activities to the amount reported as operating income (loss) in the statement of revenues, expenses, and changes in net position. This schedule should be presented on the same page as the statement of cash flows, if space permits.
Governments may acquire assets by directly assuming a liability. For example, a building may be acquired by entering into a mortgage agreement. A separate schedule should be presented describing such noncash transactions. The schedule can be in either narrative or a tabular format. Again, this schedule should be presented on the same page as the statement of cash flows, if space permits.
Fiduciary funds (trust and agency funds) are used to account for resources held by a government for other individuals or organizations. Similar to proprietary funds, fiduciary funds report using the flow of economic resources measurement focus and the accrual basis of accounting. The fiduciary financial statements should report all fiduciary funds of the primary government and any component units that are fiduciary in nature.
Fiduciary funds report two financial statements:
Unlike governmental and proprietary funds, fiduciary funds' financial statements are presented by fund type. For example, if a government has several private-purpose trust funds, only one column should be presented in the financial statements for this fund type. Also, total columns are not used in the financial statements.
The statement of fiduciary net position reports the assets, liabilities, and net position for each fiduciary fund type (agency funds should not report net position because the funds' assets should equal liabilities). The statement does not include certain actuarial liabilities of defined benefit pension plans and other similar defined benefit plans. Fiduciary trust funds generally report net position simply as net position held in trust for others. The requirement to report net position in three separate classes does not apply to fiduciary trust funds.
The statement of changes in fiduciary net position reports additions to and deductions from net position for each fiduciary fund type. Revenues and expenses are not reported. Because agency funds have no net position, they would not be reported in the statement of changes in fiduciary net position.
In business, it is often easy to determine what separate legal entities should be included in the financial statements of a corporation. It is based on ownership. The financial statements will consolidate financial information of the parent company and legally separate subsidiaries. Often there is no ownership for governments and it is more difficult to determine what entities to include. Governments come in all shapes and sizes. Some general-purpose governments provide a full range of services, although others provide only limited services. Often additional services are provided by separate special-purpose entities. Under what circumstances should these separate legal entities be included in the financial statements of the general-purpose government? This chapter will try to answer that question.
Governments can provide a range of services in a number of different ways to meet local needs. Sometimes, governments will establish separate legal entities to provide certain services to meet certain needs. Alternatively, they may provide financial support to existing separate organizations or may join with other governments in providing a regional approach to providing services. Examples include jails, airports, housing, and building authorities.
Should these separate legal entities be included in the government's financial reports, and if so, how? Traditionally, accountants look to substance over legal form in financial reporting requirements. GASB Statement No. 39, Determining Whether Certain Organizations Are Component Units, relies on a financially accountable criterion to determine which entities should be included in the financial statements of a government.
The reporting entity for a government is defined as the following:
1. Primary government
2. Component units
a. Blended
b. Discretely presented
To better understand this concept, it is important to clearly understand what a primary government is and what component units of a primary government are.
The primary government is at the core of the financial reporting entity and consists of the following:
A special-purpose government may also be considered a primary government if they meet all of the following criteria:
If a special-purpose government does not meet all the preceding criteria, it becomes a potential component unit of another primary government. To be classified as a component unit of a primary government, a special-purpose government must first be a legally separate entity.
Entities that are not legally separate would normally be included as part of the government that holds the related legal powers.
To be a component unit of a primary government, the legally separate special-purpose government must also be financially accountable to the elected officials of the primary government. How is this determined? If a legally separate special-purpose government meets any of the following three tests, then it is a component unit of the primary government.
The primary government appoints the voting majority of the governing board of the entity.
Governments often appoint the majority of certain entities' boards. However, just appointing a majority is not enough to determine if the primary government is financially accountable for this entity. One of the following tests must also be met:
Examples of a Government Being
Able to Impose Its Will |
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Examples of a Financial Benefit
or Burden Relationship |
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For entities where the majority of the board is not appointed by the government, the last two tests apply.
The entity is fiscally dependent on the primary government.
Sometimes separate legal entities are fiscally dependent on the primary government. The following are examples of fiscal dependency:
In addition, to meet the fiscally dependent test, there must also be ongoing financial benefit or burden relationship between the primary government and the separate legal entity.
The financial statements would be misleading if data from the entity were not included.
This last test requires professional judgment. In most cases, special-purpose governments are reported as component units because they meet the first two tests. However, there may be special circumstances where it would be misleading to exclude a separate legal entity from the financial statements of a primary government. Such determination is based on the nature and significance of the potential component unit's relationship with the primary government. An example would be a special financing authority created to provide temporary financial assistance to a local government in financial distress, which did not meet the first two tests.
(Guidance for tax-exempt organizations is contained in GASB Statement No. 39, Determining Whether Certain Organizations are Component Units.)
Certain other organizations warrant inclusion in the primary government's financial statements because of their relationship and significance to the primary government (for example, foundations and other organizations that support the programs of the primary government). A legally separate, tax-exempt organization is considered a component unit of a primary government if it meets all of the following three tests:
In addition, other organizations should be evaluated as potential component units if they are closely related to, or financially integrated with, the primary government. Professional judgment is used to determine if the relationship and significance of the organization to the primary government warrant inclusion as a component unit.
Some component units issue separate financial statements. These financial statements should also include any component units of the entity producing the financial statement. If a component unit of the primary government has its own component units, these component units must also be included in the financial statements of the primary government. Separately issued financial statements of a component unit should acknowledge that it is a component unit of another government. The notes to the financial statements should identify the primary government in whose financial reporting entity it is included and describe its relationship with the primary government.
One last thing, an entity can be included only as a component unit by only one primary government even if it passes the tests to be reported as a component unit for more than one government. For example, a state government may appoint an entity's governing board, but the entity may also be fiscally dependent on a local government. Usually, the fiscally dependent test will take precedence over the other tests.
Once an entity has been determined to be a component unit of the primary government, the next decision is how it should be reported in the financial statements. There are two different methods, blending and discrete presentation.
Blending combines the financial information of the component unit with the existing funds of the primary government in the financial statements. In essence, a blended component unit appears just as another fund in the financial statements of the primary government. However, the general fund of a blended component unit should be reported as a special revenue fund, not combined with the general fund of the primary government.
4. Which statement is accurate regarding the reporting of component units?
A government is required to blend the financial information of a component unit if any of the following four circumstances applies (blending does not apply to tax-exempt organizations):
GASB Statement No. 80, Blending Requirements for Certain Components, was issued in January 2016 and is effective for reporting periods beginning after June 15, 2016. The statement requires that a component unit be included in the reporting entity financial statements using the blending method if it is organized as a not-for-profit corporation in which the primary government is the sole corporate member.
If the preceding circumstances are not met, then the component unit will be discretely reported in the financial statements (discrete presentation). Discrete presentation reports the financial information of a component unit in a column separate from the primary government in the government-wide financial statements.
What happens if there is more than one discretely presented component unit? GAAP requires that information about each major component unit be provided in the basic financial statements. There are three ways a government can meet this requirement:
Component units that are fiduciary in nature should not be reported in the government-wide statements. Government-wide statements exclude all fiduciary funds and fiduciary component units. Fiduciary component units are reported only in the fund financial statements along with the primary government's fiduciary funds.
One last issue, a component unit may have a different fiscal year than the primary government. Such a component unit is presented in the basic financial statements using the component unit's fiscal year. Generally, component units' information should not be more than nine months older than the primary government, unless including the newer information would unduly delay issuing the financial statements.
A local government may join with other area governments to provide certain services. These multigovernment arrangements will often not meet the criteria to be treated as a component unit by any individual government. So how should each government report their participation in such arrangements? That depends on the nature of the arrangement.
There are two general types of multi-government arrangements: joint venture and jointly governed organizations. The main difference between the two is that a joint venture creates an ongoing financial relationship with the participating governments, where a jointly governed organization does not. Both types of organizations are included in note disclosures by the participating governments.
For joint ventures, the arrangement may create an explicit, measurable equity interest for the participating governments in some or all of the resources of the joint venture. In this case, a government should report its interest in the joint venture in the government-wide statements as a single line item. For the fund financial statements, governmental funds should report an interest in joint ventures only to the extent that the interest represents financial assets. For proprietary funds, the “investment in joint venture” account reported in a proprietary fund should report the participating government's equity interest calculated in accordance with the joint venture agreement.
Financial statements for governments include both fund-based and government-wide statements. There are separate sets of fund financial statements for each fund type: governmental, proprietary, and fiduciary. The fund financial statements focus on major funds. Each major fund is reported in separate columns and the nonmajor funds are combined and reported as a separate column. Major fund reporting applies only to governmental and enterprise funds. Internal service funds and fiduciary funds report separate columns for each fund type.
The required financial statements for each fund type are different. Governmental funds report a balance sheet and a statement of revenues, expenditures, and changes in fund balances. Proprietary funds report a statement of net position (or balance sheet), a statement of revenues, expenses, and changes in net position, and a statement of cash flows. Fiduciary funds report a statement of fiduciary net position and a statement of changes in fiduciary net position.
A government's reporting entity includes the primary government and its component units. Component units are separate legal entities that are financially accountable to the elected officials of the primary government. In addition, certain other tax-exempt organizations warrant inclusion in the primary government's financial statements as component units because of their relationship and significance to the primary government. There are a variety of tests used to determine if an entity is a component unit.
Component units are either blended or discretely presented in the financial statements of the primary government. Blending reports component units as funds of the primary government. Discrete presentation reports component units in separate column(s) of the government-wide statements. Other related organizations, such as joint ventures and jointly governed organizations, should be disclosed in the notes to the financial statements.
Separate sets of fund financial statements are prepared for which fund category?
In the fund financial statements, a government should include a separate column, except for which major fund?
Which fund must always be reported in a separate column in the fund financial statements?
Which statement is NOT accurate?
Which fund financial statements are required for governmental funds?
Which set of fund financial statements would normally contain a reconciliation of the fund financial statement information to the government-wide financial statements?
Which fund type would report additions and deductions in the fund financial statements?
Reporting separate columns for each major fund applies to which fund type?