The User's Perspective

November 2006

Fund Balance: Tell Us What You Want to Know

            An article in the May 2006 issue of The User's Perspective detailed issues that have caused fund balance information to be less useful than it should be. These shortcomings have led users to believe fund balance is something other than what it really is. In October, the Governmental Accounting Standards Board (GASB) issued an Invitation to Comment (ITC), Fund Balance Reporting and Governmental Fund Type Definitions, to lay out approaches to resolving those issues, with an eye toward gathering opinions from financial statement users, preparers, and auditors about what solutions they think are best. This article describes those approaches and relates how you can play an important role in shaping the future of fund balance reporting.

Governmental Fund Type Definitions

            The ITC discusses aspects of the definitions of three governmental fund types—special revenue, debt service, and capital projects—that are the source of variations in reporting from government to government. At least three parts of the special revenue fund definition are problematic (in bold below):

Special revenue funds—to account for the proceeds of specific revenue sources (other than trusts for individuals, private organizations, or other governments or for major capital projects) that are legally restricted to expenditure for specified purposes.

Proceeds of specific revenue sources

            The phrase proceeds of specific revenue sources means that the basis for reporting a special revenue fund in the financial statements is to track a particular source of revenue. Yet, some special revenue funds do not report a specific revenue source but rather are intended to present the finances related to particular activity, such as social services. Such funds may not track any original revenue source at all but are composed entirely of transferred resources. Some special revenue funds that report a specific revenue source also contain resources transferred from other funds, while others do not. Other special revenue funds bring together multiple revenue sources that are limited to being used for a similar purpose, such as license fees and motor fuel taxes that finance highway operations and maintenance. This variety in the uses of special revenue funds can make it difficult to determine the nature of limitations on how resources can be used, not to mention whether limitations even exist.

            The ITC considers three ways to bring some consistency to the use of special revenue funds. All three share in common the requirement that a specific revenue source is required to report a special revenue fund in the first place. The three options consider what other resources may be reported in a special revenue fund as well. One option would stipulate that only the specific revenue source may be included. A second option would allow governments to transfer in resources that are required as a match to obtain the specific revenue source. For example, some intergovernmental aid requires that the recipient government kick in money of its own. The third option also would allow the transfer of resources that are legally limited to being used for the same purpose as the specific revenue source.

Legally restricted

            Another issue related to the specific revenue source derives from the phrase legally restricted. Historically, this phrase has been understood to mean that a legally binding limitation has been placed on resources such that they can only be used for a particular purpose. For example, certain revenues may be limited by a state to being used to finance elementary and secondary education. However, the level of legal authority required to establish those limitations has never been specified in the authoritative literature. Some special revenue funds have been created to report resources limited by external parties, such as federal grant revenues, whereas other special revenue funds report resources limited by a government's own ordinances, resolutions, or administrative actions.

            Additional confusion arose when GASB Statement No. 34, Basic Financial Statements—and Management's Discussion and Analysis—for State and Local Governments, introduced the reporting of restricted net assets. That standard defined restrictions as deriving from external parties or sources (such as another government or bond covenants), constitutional provisions, or enabling legislation. Many specific revenue sources that are reported in special revenue funds carry limitations that were not imposed by an external party and that, although legally based, do not rise to the level of being enabling legislation. The ITC raises the question of whether the specific revenue source around which a special revenue fund is created should be restricted, as defined by Statement 34, or if it can be legally limited in other ways as well. The ITC suggests a definition for legally limited:

Resources that are legally limited to a particular purpose by a government cannot be used for any other purpose unless the government removes or changes the limitation by taking the same action it employed to impose the limitation initially or by taking a higher-authority action.

This definition would encompass limitations that qualify as restrictions, as well as other forms of legal limitations that may be imposed by a government itself.

Specified purposes and rainy-day funds

            The phrase specified purposes should be understood to mean a purpose that is narrower than the basic activity of the government itself. In this context, purposes refers to the objects of spending or usage, rather than circumstances. That is, purpose limitations stipulate what the revenues can be expended for, not when they can be expended. This has important implications for governments that use special revenue funds to report rainy-day, contingency, or stabilization funds, which contain resources that may be limited to being used under specific circumstances but not for a particular purpose. The requirement that resources be used for specified purposes suggests that rainy-day funds generally should not be reported as special revenue funds but should be included within the general fund.

            An additional reason that rainy-day funds generally do not qualify to be reported as special revenue funds is that they are not created around a specific revenue source. A typical rainy-day fund is replenished via a formula that requires the setting aside of a specific percentage of fund balance in excess of a stated maximum or a specific percentage of the excess of general fund revenues over expenditures. Rainy-day fund resources come from a government's general revenues, rather than from a particular source of revenue.

            However, it is apparent to the GASB that financial statement users want information about rainy-day or contingency resources. Therefore, the ITC discusses the issue and poses questions about how best to reflect that information in the financial statements. Options might include clear identification within the general fund, note disclosure or a supplemental schedule, or a separate rainy-day fund type.

Debt service and capital projects funds

            The definitions of the debt service and capital project fund types do not require the resources they report to be limited to those purposes. Resources in those funds may be restricted (as defined in Statement 34), or legally limited in some other manner, or intended by a government to be used for those purposes. In practice, some governments also have used those funds as temporary storage for resources they do not wish to show as unreserved fund balance in the general fund. These governments do not intend to use those resources to repay debt or to finance capital projects.

            The ITC offers two alternative revisions to these fund type definitions. One would allow these funds to report only resources that are legally limited to repaying debt or financing capital projects (including restricted resources). The other alternative also would allow resources intended by a government for those purposes. The rub is in how one defines what is required to establish a government's intention. The ITC discusses this issue and considers alternatives that would prohibit the reporting of intended uses, require it, or continue to allow it as an option.

Fund Balance Classifications

            The potential modifications to the fund type definitions address the types of resources that can be reported in the funds and the circumstances under which resources may be transferred. The ITC then considers how those resources should be arranged and identified in the balance sheet. The ITC presents three different models of categorizing fund balance in the balance sheet. The first, Model A, would retain the current categories but would make changes to address the issues identified above. (Model A is illustrated in Exhibit 3.1 on page 29 of the ITC.) For example, this model would make clear that fund balance should be understood from the perspective of the individual fund. Therefore, reservations indicate a more specific purpose than the fund itself communicates. For instance, fund balance might be reserved for bridge rehabilitation within a broader capital projects fund. However, if those resources were reported in a bridge rehabilitation fund, they would be reported as unreserved because they are available for the purposes of the fund. This notion is explained further in Figure 1 on page 20 of the ITC. All three models presented in the ITC assume that if a government expresses its intention to use resources for a particular purpose by taking certain actions, it would be required to identify those resources separately in fund balance (with a designation under Model A).

            Like Model A, the second model—Model B—would emphasize that fund balance is reported from the perspective of the individual fund. (Model B is illustrated in Exhibit 3.3 on page 31 of the ITC.) Model B, however, classifies fund balance to make two distinctions. First, it distinguishes between resources that can be appropriated and those that cannot (for instance, inventory and long-term receivables). The appropriable fund balance is further distinguished between resources that are "committed" to particular purposes and those that are available for any purpose of the fund in which they are reported. The committed fund balance would include resources that are legally limited (including restrictions) and those that are intended for specific purposes. Because users need to understand the difference between legal limitations and intentions, Model B would include a required note disclosure that disaggregates committed fund balance. (See Exhibit 3.4 on page 32 of the ITC.)

            Model C makes its distinction in appropriable fund balance between resources that are restricted and unrestricted, as defined in Statement 34. (See Exhibit 3.5 on page 33 of the ITC.) Unrestricted fund balance is further broken down between resources "assigned" to particular purposes (essentially the same as designated) and those that are "unassigned." Unassigned resources are available for any purpose, not just for the purposes of the fund they are reported in. 

How You Can Shape the Future of Fund Balance

            The purpose of the ITC is to find out what potential changes to fund balance information would best suit your needs. Toward that end, the GASB has created an Internet-based survey that poses questions about the alternative approaches to revising fund type definitions and classifying the components fund balance. The results of that survey will be combined with other feedback the GASB receives to inform the development of proposed new standards for fund balance reporting.

            The first thing you should do is download the ITC, which is available free from the GASB website. Once you have read through it, take the survey.

            You also can participate in a roundtable discussion exclusively for external users of financial statements. The roundtable will be held in New York City on February 1, 2007. Details about the roundtable and how to notify the GASB of your intent to participate can be found in the front of the ITC.

            If you have any questions about the ITC, please feel free to contact GASB staff members Ken Schermann ( or 203-956-5206) or Dean Mead ( or 203-956-5294).

Further Reading