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Chapter Twelve
Lecture Notes
Unique Aspects of Accounting
for State and
Local Governments – Part I:
The Recording Process
1
A Third Basis of Accounting:
Modified Accrual



Cash Accounting recognizes revenues when cash is received and
expenses when bills are paid (focus on cash movement).
Accrual Accounting recognizes revenue when goods or services have
been provided and recognizes expenses when resources have been
used (focus on when revenues are earned or resources are consumed).
Governmental funds use Modified Accrual Accounting. Expenditures
are recognized when resources are received. Revenues are
recognized when they are measurable and available within the
accounting period or shortly afterwards (focus on financial resources).
–
Financial resources are cash or assets that can be translated
to cash, less current liabilities.
2
Inflow (Revenue) Recognition
Measurable
and Available
Payment has been
received or will be
received soon.
Modified
Accrual Basis
Earned
Service has
been provided.
Accrual
Basis
Collected
Payment has
been
received.
Cash
Basis
Note: Governmental resource inflows are available if they are deemed to be
collectable during or shortly after the end of the accounting period. This may
happen before cash is received.
3
Outflow (Expense or Expenditure)
Recognition
Encumbrance
Delivery
Appropriation
Authorization
to spend money.
No expense
at this time any basis.
4
Order has
been placed.
No expense
at this time any basis.
Payment
Order has
been received
by buyer.
Modified
Accrual
Basis Expenditure
now.
Payment is
made.
Use
Item is
consumed.
Cash
Basis
Accrual
Basis
Expense
now.
Expense
now.
Implications of Modified Accrual
Accounting



No long-term assets.
- Long-term acquisitions such as buildings and equipment
are recognized as expenditures when acquired.
- There is no recognition of depreciation.
No long-term liabilities.
- Principal (repayment of debt) and interest are recognized
as expenditures when paid.
Proceeds from borrowing are treated as a nonrevenue source
of fund balance rather than as a liability.
5
Differences Between
Bases of Accounting
Accrual
Modified Accrual
Outflows
(Expenses or Expenditures)
When resource
is used
When resource is acquired,
legal obligation to pay exists
and payment will come from
available resources
Inflows
(Revenues)
When resource
is earned
When resource is legally
owed, measurable and
available
Assets
Current and long
term
Current
Liabilities
Current and
long term
Current
6
Governments
and Fund Accounting

Governments use funds to account for separate sub-entities.

Governments have three major classes of funds:
- Governmental funds account for the operating activities
of governments (Modified Accrual Accounting).
- Proprietary funds account for activities that are run on
a business-like basis (Accrual Accounting).
- Fiduciary funds account for the government's activities
as trustee and agent (Accrual Accounting).
7
The Governmental Funds

Governmental funds include:
- General Fund used for the bulk of the day-to-day revenues
and expenditures of the government.
- Special Revenue Funds for the revenues and expenditures
of specific activities that are subject to legal or managementimposed restrictions.
- Capital Project Funds to account for major acquisitions of
plant or equipment.
- Debt Service Funds to account for the accumulation of
resources to pay for principal and interest on long-term debt.
- Permanent Funds, which are similar to endowment funds.
8
Proprietary Funds

Proprietary Funds are used for activities that are run on a
business-like basis. Revenues come from fees, tolls, and
other charges:
- Internal Service Funds are established to account for
elements of the government that provide services to other
governmental units.
- Enterprise Funds are established to track the activities of
governmental units which provide goods and services to
individuals and organizations outside of the government.
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Fiduciary Funds

Fiduciary funds are held for another. They are not the
resources of the government.
- Trust Funds are established whenever money is given to
a government under the terms of a trust agreement such as
for an employee pension plan or an unemployment
compensation fund.
- Agency Funds are used to account for money that a
government is holding for some other operating entity like a
volunteer fire department or another level of government.
10
Modified Accrual Transactions

The Town of Millbridge buys and receives some fireworks on
January 15th that it intends to use on July 4th. It receives a bill
from the manufacturer for $50,000. How would the transaction be
recorded by the Town under modified accrual accounting?
Modified accrual accounting (purchase approach)
Assets
No Change

= Liabilities
+
= A/P + $50,000 -
Fund Balance
Expenditure $50,000
Governments generally record transactions using modified accrual,
but have the option of using modified accrual or accrual for
prepayments, materials, and supplies.
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Property Tax Transactions

Millbridge issues $611,000 in property tax bills this year. Total collections for
the year are $600,000 made up of $575,000 of this year's taxes and $25,000 from
last year's tax bills. The remaining $36,000 from this year is expected to be
collected within 60 days of year-end. It is "available." How would these financial
events be recorded?
Assets
= Liabilities
Recording the property taxes billed this year
Taxes
Receivable + $611,000
= No Change
+
Fund Balance
+
Tax
Revenue $611,000
Recording the receipt of $600,000 in collected taxes
Cash + $600,000
Taxes Receivable - $600,000 = No Change
+

No Change
Where are the $25,000 in last year’s collected taxes and the $36,000 in
uncollected taxes from this year in these transactions?
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Long-Term Liabilities
Modified Accrual Accounting


When a government borrows money on a long-term basis:
- no liability is created on the balance sheet.
- cash is increased and the fund balance is increased.
This is how a $1,000,000 loan would be recorded:
Assets
= Liabilities
Cash + $1,000,000 = No Change

+
Fund Balance
Other Financing
+ Sources $1,000,000
Note that the increase in the fund balance is not referred
to as revenue.
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An Interfund Transaction
During the fiscal year the general fund was legally required to transfer
$100,000 to the debt service fund. Only $97,000 was transferred.
How would this transaction be recorded?
Assets
=
Liabilities
+
=
Due to
DSF + $3,000 -
Fund Balance
General Fund
Cash - $97,000
Other Financing Use
Transfer to DSF
$100,000
Debt Service Fund
Cash + $97,000
Due from GF + $3,000 =
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No
Change
+
Other Financing Source
Transfer from GF $100,000
Debt Repayment Transaction

The interest and principal due on Millbridge's debt during the year
were $15,000 and $50,000, respectively. Payments were made
from the debt service fund. How were the payments recorded?
Debt Service Fund


Assets
Cash
- $65,000


= Liabilities
=
No
Change
+
-
Fund Balance
Interest
expenditure
$15,000
Principal
- expenditure
$50,000
Both the interest and the principal were recorded as expenditures.
Would the transaction have been recorded in the same way under
accrual accounting?
Why was
15 there no change in any liability account?
Acquiring a Building


Assume that a building is purchased for $270,000, with full
payment in cash.
What if the Town issued a bond for $270,000 to pay for the
building?
16
Transactions for
Acquiring a Building
Capital Projects Fund
Assets
=
Liabilities
+
Fund Balance
Acquisition Using Available Cash
Cash - $270,000 = No Change
Building acquisition
- expenditure $270,000
Purchase of the Building by Issuing Bond
Other sources of
Cash + $270,000 = No Change
+ financing
$270,000
Cash - $270,000 = No Change
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Building acquisition
- expenditure $270,000
Budgetary Accounting

Government budgets are recorded in
their accounting systems.

Aids compliance with legal spending
restrictions.

Aids budget control.

Uses system of appropriations and
encumbrances.
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Budgetary Accounting Example –
Supplies Budget
Appropriation
Less: Expenditures
Less: Encumbrances
Amount Available for Spending
$ 130,000
0
0
$ 130,000
Supply order for $60,000 is placed. If someone wanted to
place another order they would find that the balance available to
spend is:
Appropriation
Less: Expenditures
Less: Encumbrances
Amount Available for Spending
19
$ 130,000
0
60,000
$ 70,000
Budgetary Accounting
Example, continued
When the supplies are received, the encumbrance transaction
is reversed, and an expenditure transaction is recorded:
Appropriation
Less: Expenditures
Less: Encumbrances
Amount Available for Spending
$ 130,000
60,000
0
$ 70,000
Suppose another order is now placed for $50,000 of supplies.
The supplies account would be encumbered, and the new
balance available to spend would be $20,000, as follows:
Appropriation
Less: Expenditures
Less: Encumbrances
Amount Available for Spending
20
$ 130,000
60,000
50,000
$ 20,000