Government and Not-for-Profit Accounting, Binder Ready Version: Concepts and Practices, 7th Edition Class Notes

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Chapter 1Chapter 1The Government and Not-for-Profit EnvironmentIn the first session or two, (after addressing course mechanics–the syllabus, policies,etc.) I present the objectives of the course.I note that my priority ranking of theobjectives is likely to be close to the reverse of that of the students.I emphasize thatthe course will, in fact, prepare students for the CPA exam, but that preparation for theCPA exam preparation is not the course’s primary objective.I then ask the students why we have a course in governmental and not-for-profitaccounting when we have no such similar courses for other “industries.”Or, to put inanother way, why we have two standard boards–one for government; the other for allother types of entities.In the course of the discussion that ensues, I try to key on thepoint that a central purpose of accounting is to measure entity performance.In thebusiness sector, the objective of the entity is to earn profit; hence the financialstatementsfocusonprofit.Governmentalandnot-for-profitorganizationshaveobjectives other than profit; therefore it would be no sense to focus profitability.I start the discussion by asking the students what they did in the morning right aftergetting up. For example, using the water, dropping of their kid to school, the road theytravelled on, the streets etc–it is all public sector and is part of every facet of their life.I also emphasize the importance of the Public Sector (PS) by showing a video from theAGA that states that the PS is 50% of the economy.Additionally, most of you(addressing to the students)can expect to have some involvement with government andnot-for-profit entities during your professional careers, either as aController/CEO of agovernmental/NFP entity, as an auditor with a public accounting firm orStateAuditor,or as an accountant or financial manager with such an entity, be on the Board of anNFP or even hold a public office.I try to convince the students that governmental and not-for-profit accounting is farmorechallengingthanbusinessaccounting.Ingovernmentalandnot-for-profitaccounting we face all of the same issues as in business accounting (i.e. manygovernments and not-for-profits engage in business-type activities), plus many more.Examples:We have first to determine the objectives of the entity, then measure how wellthey have been achieved (I engage in a brief discussion of what are theobjectives of organizations with which they are familiar, such as a policedepartment or a university).In making capital budgeting decisions in business, we typically compare costswithbenefits–i.e.cashinflowswithcashoutflows.Innot-for-profitorganizations the benefits are not easily defined, let alone measured (e.g.whatis the benefit of a new fire station?; what is the value of the lives that might besaved?).

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CommentsPage2Chapter 1In assessing the fiscal strength of a business, we focus mainly on the net assets(both tangible and intangible) of the business itself.By contrast, the fiscalstrength of a government cannot be assessed by measuring only (or evenlymainly) its own assets.Instead, we must take into account the resources of itsjurisdiction–those that it can draw upon if and when needed. These include theassets of its businesses and residents. Thus, we must perform a comprehensiveeconomic analysis.At the same time we must consider the demands that thecitizenry will make upon the government.Hence we must also evaluate avariety of demographic, political and social factors.To both emphasize the latter point and to try to put into perspective the role of accountingand financial reporting, I review the file, “A City’s Fiscal Status; A Strategic Analysis.”I ask the students to identify the characteristics that distinguish governments frombusinesses and use the GASB’s statement of objectives (see computer file) to assure thatwe identify all the major differences.I then try to show that at least some of thesecharacteristics also apply to not-for-profits.I then ask the students the purpose of a statement of objectives and review the GASB’sobjectives. I focus on the first objective (“Should assist in fulfilling government's duty tobe publicly accountable and should enable users to assess that accountability”). I ask thestudentswhethertheythinkthisobjective,includingitsthreesub-objectives,arereasonable.They almost always agree that they are.I then present them with theproblem (see computer file “What Number do You Have in Mind?” I call on a student toprepare a statement of activities consistent with the first two sub-objectives (interperiodequity and budgetary compliance). The question arises as to whether the cost of thevehicles should be expensed in the year of acquisition (i.e. consistent with the budgetarycomplianceobjective)ortheyearsofuse(consistentwiththeinterperiodequityobjective) I assert that this conflict underlies much of the difficulty that the GASB hasfaced in establishing accounting principles and is the reason why GASB Statementrequires, in effect, two sets of financial statements.

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Chapter 2Chapter 2Fund AccountingI begin this chapter by defining a fund and emphasizing that each fund is a separateaccounting and fiscal entity that can be defined by the fundamental accounting equation(assets = liabilities + “owners’” equity. Accordingly,I note,the resources and activitiesof a fund can be described by the same basic statements as those of a business (i.e. abalance sheet, an “income” statement and a statement of cash flows.)I note, however,that the GASB has now distinguished between assets and deferred outflows and betweenliabilities and deferred inflows. Hence, the basic accounting equation for a government isnow:Assets + deferred outflows = liabilities + deferred inflows + fund balance (or net assets)I then discuss the reasons for fund accounting, stressing that it is mainly a control deviceto assure that governments and not-for-profits comply with restrictions as to the purposesfor which resources can be used. I contend that there is nothing inherent in governmentsor not-for-profits that necessitates fund accounting.I spend the majority of a session reviewing the basic financial statements (government-wide and funds) and the fund structure of a government. I recommend basing the sessionon the statements of your own city or some other city with which your students canidentify (and which can be downloaded from the internet). I then discuss the meaning of“measurement focus and basis of accounting.” I ask the students to take particular note ofthe types of assets and liabilities in each of the fund types and on the basis of these assetsand liabilities to determine the measurement focus and basis of accounting of the variousgovernmental funds. It quickly becomes clear that since the governmental funds includeassets other than cash, they cannot possibly be accounted for on a cash basis. Butinasmuch as they exclude capitalassets (such police cars, buildings, equipment, etc.),they also cannot be accounted for on a full accrual basis. This discussion leads to anexplanation of the need for some sort of off the balance sheet records keep track of assetsand liabilities that otherwise would be written-off at time of acquisition.Because the form and content of the government-wide balance sheet is similar to that of abusiness, I spend relatively little time on it. I spend approximately 20 minutes discussingthe form and content of the government-wide statement of activities. I try to emphasizethat, although it may be in an unfamiliar form, it makes intuitive sense–that is, in theupper portion of the statement we determine the amount that has to be covered by generalrevenues; in the lower portion we identify those revenues.I go to great lengths to emphasize that the fund structure ofa government or not-for-profitis almost never coincident with its organizational structure. Funds are establishedto account for resources that are restricted for specific purposes, not for organizationalunits. Hence, the general (or operating) fund, accounts for the majority of transactionsengaged in by a government’s operating departments.

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CommentsPage2Chapter 2I then attempt to get the students to understand the relationship between funds. I go overa series of transactions, a couple of which involve two or more funds (See files“Relationships Among Funds”). To emphasize that each fund is an independentaccounting and fiscal entity, I assign each fund to a specific student. As I go over eachtransaction I ask the class to identify the one or more students who are accountable forrecording the transaction. Although I focus on the fund statements (and thus on themodified accrual basis), I ask the students for the entries that would be made to reflect thetransactions on a full accrual basis.I conclude the sessions on Chapter 2 with a discussion of the reporting requirements perGASB Statement No. 54,Fund Balance Reporting and Governmental Fund TypeDefinitions.

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Chapter 3Chapter 3Issues of Budgeting and ControlI introduce this chapter by telling (somewhat facetiously) the students that much of thematerial dealt with in this chapter–specifically, that dealing with budgetary entries andencumbrances–is the least important in the text. That is because budgeting entries haveno effect on the financial statements and encumbrances have but a minor effect.Nevertheless, both budgetary entries and encumbrances are significant in that they areimportant control mechanisms. Indeed, insofar as the students work for government ornot-for-profit entitiesbudgetary entries and encumbrances may someday enable them toavoid the consequences, such asembarrassment or even jail time (a bit of hyperbole,perhaps)by preventing them from overspending their budgets. Further, the chapter maybe of more immediate interest to them in that budgetary entries and encumbrances aregiven prominent attention on the CPA exam.I begin the substantive portion of the discussion by displaying a budget to actualcomparison of a local government. I emphasize the difference between the originalbudget and the amended budget and point out the reporting objectives (legal compliance;managerial efficiency) that are served by requiring both to be presented. I also point outthe key potential differences between legally adopted budgets and GAAP-based financialstatements (i.e., basis, timing, perspective and reporting entity).To cover budgetary entries, I go over the transactions on the computer file “BudgetaryEntries.” I stress that since the budgetary entries are reversed at year-end, the effect is thesame as if the entries had never been made. I also point out that many governments debitor credit the initial budgetary entries to “budgetary fund balance” so as not tocontaminate the “true” fund balance (an approach that I personally prefer).To cover the encumbrance entries, I go over the transactions on the computer file,“Encumbrances and Expenditures.” These transactions, along with the resultant end ofyear financial statements, make the encumbrance process intuitively appealing. As theresult of the process, the government, in the first year, orders $6,000 of goods andservices but receives and uses $5,000. Accordingly, it charges $5,000 in expenditures butreserves $1,000 of fund balance to accommodate the goods still on order. In the secondyear, the government receives and uses the remaining goods and services. Although itestimated that the cost would $1,000, it is, in fact, only $950. Hence it charges only $950in expenditures. Since the $50 balance in the reserve for encumbrances account is nolonger required, it is restored to unreserved fund balance. Per the entries (and this pointis the most difficult for students to grasp), the net amount of $50 that is restored consistsof $1,000 that is added back to unreserved fund balance (the first entry of the secondyear) and $950 that is deducted (charged as the expenditure).

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Chapter 4Chapter 4Recognizing Revenue in Governmental FundsI begin the discussion of revenue recognition by explaining the relationship betweenmeasurement focus and basis of accounting. I note that we can focus on anywhere from asingle asset (e.g. cash) to a wide range of assets (e.g. all economic resources). The rangeof assets that we choose to focus on automatically establishes the basis of accounting. Ifwe focus on cash, we will use a cash basis of accounting; if on all economic resourcesthen we will be on a full accrual basis.If we focus on a limited range of net assets (e.g.current financial resources) then we will be on a basis of accounting in between the cashand full accrual (i.e. a modified accrual basis of accounting).Citing and quoting from Section 1600 of the GASBCodification,I describe and justifythe measurement focus and basis of accounting as established by the NCGA and adoptedby the GASB and which underlies the fund statements.I then explain what is meant by“measurable and available.”I review briefly the basic provisions of GASB Statement No. 33 using the Power Pointpresentation which is included with the files for Chapter 4.I do not spend an inordinateamount of time on this presentation as I have found that the students benefit far morefrom discussions of actual revenue recognition issues.Therefore, I center most of thetime allocated to revenue recognition on the transparency, “Issues Relating to Revenues.”I am able to generate considerable discussion as to when each of the revenues in questionshould be recognized.For each I raise the question of what constitutes the significantevent in the “earning” process, and when the resources to be received are available forexpenditure. I try to show that there is often a conflict between when the government has“earned” its revenues and when it can first spend them.I compare how each transactionwould be recognized in both the fund and the government-wide statements.While going over the transactions, I discuss GASB Statements No. 63 and 65, both ofwhich pertain to deferred inflows and outflows.I conclude the sessions on revenue recognition with a discussion of investment gains andlosses–in essence GASB Statement No. 31,Accounting and Financial Reporting forCertain Investments and for External Investment Pools,which mandates that investmentsbe “marked to market.”I use the Excel file “Investment Example” to illustrate howperiod gains and losses can be readily computed (i.e., by subtracting the “inputs” fromthe “outputs.”I usually have no difficulty convincing students as to the virtues ofrecognizing unrealized gains and losses on equity securities inasmuch as they aregenerally familiar with the corresponding FASB requirements.Far more challenging isjustifying the need to do the same for held-to-maturity bonds.I focus mainly on theopportunity costs that a government incurs when it locks into a long-term investmentonly to see prevailing interest rates rise and, as a result, the market value of investmentfall.I also, however, emphasize the negative consequences of marking long-term bondsto market.The main problem, I note, is that it causes a disconnect between budgeting

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CommentsPage2Chapter 4and financial reporting in that the reported gains and losses have no impact on cash flows.Thus governments may have to report surpluses or deficits when for budgeting purposesnone exist.

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Chapter 5Chapter 5Recognizing Expenditures in Governmental FundsI begin the discussion of expenditures by noting that GASB Statement No. 33 (whichformed the basis of our sessions on revenues) applies to expenditures as well as revenues.However, it does not apply to nonexchange transactions and that most (albeit not all)expenditures of governments are exchange transactions.I then attempt to justify the modified accrual basis of accounting for expenditures byemphasizing the need, per a key GASB objective, to relate financial reporting tobudgeting.But I remind the students of the conflict, discussed the first week of class,between this objective and the need to report on the extent to which interperiod equitywasachieved.Hencetheneedfortwosetsoffinancialstatements–fundandgovernment-wide.I also remind the students that the principles to be addressed are applicable to allgovernmental funds, not just the general fund.I then turn to the file, “GASB 33 Expenditures.” In addressing the first transaction–thatpertaining to wages and related benefits, I note that many governments (including majorstates) have moved employee paydays from the last day of the month to the first of thefollowing month.This maneuver allows them to shift budgetary expenditures from onefiscal year to the next. However, it would have had no impact on reported expenditures.In discussing the fifth and sixth transactions–those dealing with installment purchasesand capital leases–I point out that as a consequence of accepted practice, the cost of anasset may be recognized as an expenditure twice–once when the asset is acquired (andthe note or lease is signed) and again as the note or lease payments are made. Of course,fund balance is reduced only once, since the initial charge is offset by a credit, “otherfinancing sources.”Students generally have difficulty accepting the standards prohibiting the accrual ofinterest on long-term debt (transaction #7) in fund statements.I justify the standards byexplaining that interest is often a major cost of government. If interest had to be accrued,but was not budgeted as an expenditure (and the cost not covered by taxes) until it had tobe paid, then governments would often have to report deficits.Of course, the adverseconsequences of this standard are most evident when governments issue zero couponbonds (transaction #15) and report no expenditures until the bonds mature.Students almost always question why sick leave is not accrued (transaction #11) unless itis to be paid as a termination benefit.I explain the underlying rationale–that illnesses(unlike vacations) are within the control of neither employer nor employee.Further, theaccounting for sick leave is comparable to that for businesses (see FASB Statement No.43).I then raise the question of how payments for other types of leaves should beaccounted for–e.g. two-week military reserve duty, jury duty, and maternity leave.

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CommentsPage2Chapter 5As I did with revenues, I prefer to discuss the impact of the transactions on thegovernment-wide statements concurrently with that on the fund statements.The maindifferences, of course, are that both long-term assets and liabilities are recognized in thegovernment-wide statements and hence the related expenses are recognized as they havetheir main economic impact. Moreover, consistent with the full accrual basis, inventoryand prepayments would be accounted for on a consumption rather than a purchases basis.Transactions #16, #17 and #18, pertain to grants. Unlike the other transactions, these arenonexchange transactions and are governed by GASB Statement No. 33.

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