The User's Perspective

November 2007


Touring the Financial Statements, Part III: The Governmental Funds

      This article continues a series begun in the last issue reviewing the basic financial statements and other required components of a state or local government's annual financial report. The first two articles covered the financial statements you would initially encounter upon opening a financial report-the government-wide statement of net assets and statement of activities. This article looks at the two required financial statements for the governmental funds—the balance sheet and the statement of revenues, expenditures, and changes in fund balances.

Background on Fund Reporting

      Prior to the implementation of GASB Statement No. 34, Basic Financial Statements—and Management's Discussion and Analysis—for State and Local Governments, governments did not report financial information covering their entire reporting entity. Rather, financial information was disaggregated among a multitude of funds—accounting devices that are used to account for and report specific aspects of a government's financial activities, such as a particular revenue source (education or transportation aid, for instance) or function (for example, capital construction, repaying debt, or water and sewer operations).

      There are three groups of funds for which financial statements are prepared—governmental, proprietary, and fiduciary. Proprietary funds are employed to report on activities financed primarily by revenues generated by the activities themselves, such as a municipal utility. Fiduciary funds contain resources held by a government but belonging to individuals or entities other than the government. A prime example is a trust fund for a public employee pension plan.

      Governmental funds account for everything else. This is where the bread-and-butter services can be found—police, fire, social services, sanitation, and so on. There are five types of governmental funds:

  • The general fund is a government's basic operating fund and accounts for everything not accounted for in another fund. 
     
  • Special revenue funds are intended to be used to report specific revenue sources that are limited to being used for a particular purpose, such as transportation aid. In practice, governments also use them to report: all of the financial activities associated with a single function (such as road maintenance); classes of revenues (for example, all federal grants); and "rainy day" resources.
     
  • Debt service funds account for the repayment of debt. If a government is accumulating resources for the purpose of making debt service payments, it should report them in a debt service fund. In reality, some resources intended to finance debt service payments can be found in other governmental funds. Furthermore, debt transactions associated with proprietary and fiduciary activities are accounted for in those funds.
     
  • Capital projects funds account for the construction, rehabilitation, and acquisition of capital assets, such as buildings, equipment, and roads. Governments are not required to account for all capital expenditures in this fund type, however, and therefore it may also appear in the general fund or even special revenue funds.
     
  • Permanent funds account for resources that cannot be expended, but must be held in perpetuity. Generally, these resources are invested and a government may spend the earnings, often for a purpose specified by the provider of the resources. 

The Nature of Governmental Fund Information

      The government-wide financial statements and the proprietary and fiduciary fund financial statements report financial information on a full accrual basis. The governmental fund financial statements, however, report what is commonly referred to as current financial resources on a modified accrual basis. Whereas full accrual contains all inflows and outflows of economic resources, short- and long-lived assets, and short- and long-term liabilities, the governmental fund financial statements generally have a short-run perspective. Governmental fund assets generally are expected to be used or liquidated within a year and governmental fund liabilities are normally expected to be repaid or satisfied with current resources. Governmental fund revenues are those collected within the year or soon enough thereafter that they can be used to finance current-year expenditures. Expenditures represent the use or expected use of current financial resources.

Major Funds

      The general fund is always shown separately in the financial statements. The largest of the other individual governmental funds, based on the amount of financial activity that takes place in them, are also shown separately. Funds that cross certain benchmarks are required to be reported separately, and governments may show smaller governmental funds separately if those funds are considered important to the government or the readers of its financial statements. The remaining "non-major" funds are aggregated in a single column on the face of the financial statements.

Figure 1. Sample Governmental Funds Balance Sheet
   

The Balance Sheet

      The governmental funds balance sheet presents first a government's assets, resources it controls that enable it to provide services. (See Figure 1.) Given the basis of accounting, these assets are generally current in nature—cash, short-term investments, and short-term receivables. Most notably absent are capital assets. However, some assets that are not current or not financial may still creep in. For instance, the governmental funds may contain long-term receivables related to loans made from one fund to another. They also often contain inventory. How do these items make their way into statements reporting current financial resources? The answer lies in the meaning of modified accrual. Although the accounting standards have been modified to remove capital assets and long-term debts from the governmental funds, there are no specific modifications related to long-term receivables or inventory.

      The "balance" in the balance sheet is between assets on the one hand and liabilities and fund balances on the other. Liabilities are amounts owed (more precisely, virtually unavoidable obligations to sacrifice resources). The liabilities generally are expected to be satisfied within a year. You will often find deferred revenue here as well. Under accrual accounting, deferred revenues typically represent resources a government has received that are attributable to a future period. For instance, a government may receive a payment in the current year that is for the following year's property tax bills. That amount would be reported as deferred revenue until the next year. However, under modified accrual, revenues may be deferred because the resources are not available—they have not been received during the year or soon enough thereafter to be used to finance current-period expenditures. If a given year's tax payments were not received by the government in time to be considered available, then the revenue would be deferred until the payments were received.

Fund Balance

      Fund balance is the difference between assets and liabilities—in essence, what would be left over if the assets were used to satisfy the liabilities. It is, quite literally, the balance of each fund. Fund balance may be the most widely used information in the entire governmental financial report, but it is also highly problematic because of inconsistencies in the way governments interpret the relevant standards. (For a fuller discussion of the concerns raised by the GASB's research on fund balance, see Fund Balance: It May Not Be What You Think It Is in the May 2006 issue.)

      Fund balance is reported in two basic components—reserved and unreserved. Fund balance may be reported as reserved because it is related to resources that cannot be spent, like inventory, or because there is a constraint on how the resources may be spent that limits them to use more specific than the purpose of the fund. For instance, a government may enact an ordinance that earmarks a portion of its sales tax for elementary and secondary education. Those resources might be reported in the general fund as "reserved for education." Basically, any limitation placed on the use of resources reported in the general fund will show up as reserved fund balance. In the other governmental funds, however, resources are already understood to be devoted to the purpose of the fund—for repaying debt, or capital projects, for example. Reserved fund balance in the other governmental funds, therefore, communicates that an even more specific limitation has been placed on the resources—for example, resources in a broad capital projects fund may be reserved for a particular type of project (streets) or a specific project (city hall renovation).

      Unreserved fund balance represents resources that are available to be used for the purposes of the fund they are reported in. For the general fund, unreserved fund balance is legally available for any purpose. In a transportation-related special revenue fund, unreserved fund balance is available for transportation. GASB research suggests that roughly half of governments take advantage of the option to "designate" a portion of their unreserved fund balance. Designations indicate a government's intention to use resources for a particular purpose, though there is no force of law behind the designation and a government could change its mind and use the resources for another purpose. Although most governments that designate unreserved fund balance show the designations on the face of the balance sheet, some governments disclose the designations in the notes to the financial statements.

The Reconciliation

      The final component of the balance sheet is a reconciliation—a crosswalk between total fund balance and total governmental activities net assets in the government-wide statement of net assets. The reconciliation may appear on the face of the balance sheet (as in Figure 1) or on an adjoining page. The balance sheet reconciliation may also be accompanied by a note disclosure that presents the reconciling items in greater detail. The reconciling items are generally of two kinds—those that explain differences in the scope of activities covered (for example, governmental activities may include internal service funds, in addition to the governmental funds) and those that explain differences in the accounting bases (for instance, the presence of capital assets and long-term liabilities in the government-wide statements, but their absence in the governmental funds).

The Statement of Revenues, Expenditures, and Changes in Fund Balances

      The statement of revenues, expenditures, and changes in fund balances is the governmental funds' income statement, tracking the flow of resources in and out. (See Figure 2.) It will contain the same major funds as the balance sheet.

      Revenues are shown by source or type, such as various taxes, fees and charges, intergovernmental aid, and so on. There is not a set list of revenue categories that must be shown, nor a required level of detail, which results in some variation from government to government. Expenditures generally are shown by function and object with the current operating expenditures presented apart from debt service and capital expenditures. Some governments break the debt service expenditures into their principal and interest components. It should be noted that smaller capital expenditures may be included in the functional categories, so the line "capital expenditures" may not represent the sum total. One can generally determine the total amount of capital expenditures from the information in this statement's reconciliation (more on that below). Care should also be shown not to assume that two governments using the same functional categories are necessarily reporting comparable services. For instance, "public safety" for one government may include police and fire, but for another it may also include emergency medical services or jails.

      Revenues and expenditures are not the only inflows and outflows of resources reported in this statement. Other financing sources and uses include the cash received when bonds are issued, as well as transfers between funds. Apart from the fact that these resource flows are not revenues or expenditures, they are shown apart to assist the reader of the statement in assessing the balance between ongoing revenues and expenditures related to the basic operations of the government.

Figure 2. Sample Statement of Revenues, Expenditures, and Changes in Fund Balances
   

      For the same reason, extraordinary and special items are presented apart from revenues and expenditures. Extraordinary items are increases or decreases in fund balance that are both (a) unusual in nature and (b) infrequent in occurrence. Extraordinary items, as their name implies, do not appear in the financial statements very often. Special items are either unusual or infrequent and are within the control of the government, whereas extraordinary items seldom are. A special item might be the proceeds from the sale of a capital asset for a government that does not commonly sell capital assets.

      The bottom line of the balance sheet is the net change in fund balance—revenues minus expenditures plus or minus total other financing sources (uses) plus or minus extraordinary and special items. This amount is added to the fund balances as of the beginning of the fiscal year (generally the same amount reported as the ending fund balance for the previous year) to arrive at the ending fund balance amounts. These should match the total fund balances reported in the balance sheet.

Figure 3. Sample Reconciliation of Change in Fund Balances with Change in Net Assets
   
      Like the balance sheet, this statement also has a reconciliation. Figure 3 illustrates a reconciliation presented on the following page after the statement (as opposed to being on the face of the statement, as with the sample balance sheet in Figure 1). Whereas the balance sheet reconciliation crosswalked fund balance with governmental activities net assets, this reconciliation describes the differences between change in fund balances and change in governmental activities net assets in the government-wide statement of activities. Again, the reconciling items typically relate to differences in scope or accounting bases. For instance, change in fund balance is reduced by capital expenditures, but under accrual accounting in the government-wide statements capital outlays are reported as the capital assets they produce, the cost of which is depreciated over their useful lives. So, capital expenditures need to be added back to change in fund balance. On the other hand, the depreciation expense that reduces the change in net assets in the statement of activities needs to be taken into consideration. In Figure 3, the amount by which capital expenditures exceeded depreciation, $14,039,717, is added to the net change in fund balances of ($106,657).

Relevant Disclosures and Supporting Information

      Several required note disclosures are helpful in understanding the information to be found in the governmental funds financial statements:

  • If a nonmajor fund had a fund deficit—liabilities exceeded assets—a government should disclose it, since it cannot be seen in the aggregated non-major funds column.
     
  • If the reconciliations aggregate the reconciling items into categories that obscure the individual adjustments, then a government should provide a more detailed reconciliation in the notes.
     
  • The amount of time after the end of the fiscal year during which collections can be considered available and thus recorded as revenue is called the period of availability. Although accounting standards specify that the period of availability for property taxes is 60 days, they are silent on other revenues. Governments should disclose in the summary of significant accounting policies (usually the first note disclosure) the length of time it used to define availability for its other revenues.
     
  • Governments are required to present two notes related to financial activity among the funds:
     
    • One discloses interfund balances as of the end of the year—amounts due to and from each of the columns in the fund financial statements (including not only the governmental funds, but also the proprietary and fiduciary funds). Governments will describe the purposes for the interfund balances and identify any that are not expected to be repaid within a year.
       
    • The other discloses interfund transfers during the fiscal year—amounts transferred among the fund columns. This disclosure should also describe why the transfers were made and will single out transfers that do not occur on a routine basis or that are inconsistent with the activities of the fund making the transfer. 

Required Supplementary Information

      Governments are required to prepare a budgetary comparison schedule that tracks the progress over the course of the fiscal year of the general fund and of each major special revenue fund for which a government legally adopts a budget. (See Figure 4.) The GASB recommends that the budgetary comparisons be presented as a supplementary schedule following the notes, but governments may elect to present them as basic financial statements after the governmental funds financial statements.

Figure 4. Sample Budgetary Comparison Schedule
   
      The first three columns in Figure 4 are required. The original budget is the adopted budget and includes any modifications made to the budget prior to the start of the fiscal year. The final budget includes all modifications made to the budget during the course of the year. The third column presents the actual results for the year. Governments may include variance columns that show how the amounts changed from original budget to actual results (or original-to-final, or final-to-actual), but they are not required to do so. Even if they do not, variances are simple enough to calculate by subtracting the earlier version from the more recent version of the budget.

      The format of the revenue and expenditure categories may follow either that used in the statement of revenues, expenditures, and changes in fund balances or the format the government uses in its budget. These numbers are presented in the government's budgetary basis, which is likely to be on a cash- or near-cash-bases and therefore different from the modified accrual used in the governmental funds. Therefore, a reconciliation is required that explains the differences between the actual results column in this schedule and the numbers presented in the financial statement.

Supporting Schedules

      Some governments, including those that present their financial statements in a comprehensive annual financial report (CAFR), will prepare supporting schedules that present the detail behind columns in the fund financial statements that aggregate multiple funds. For the governmental funds statements, these combining statements show the non-major funds individually, often grouped by type of fund (in other words, capital projects, debt service, and so on).

Statistical Section

      The CAFR includes a statistical section that contains valuable detail and contextual information related to the governmental funds financial statements. The statistical section includes a schedule of fund balances and a schedule of changes in fund balances, both for the past ten fiscal years.

Further Reading

  • An Analyst’s Guide to Government Financial Statements
  • What Else You Should Know about a Government’s Finances: A Guide to Notes to the Financial Statements and Supporting Information

These volumes, part of the GASB’s User Guide Series, are available individually and in a package from the GASB.

  • Learn more about the user guides
  • See a slide presentation on the user guides
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