Accounting and Financial Condition. Lecture 10 Outline Overview Financial statements—pre-GASB 34. GASB 34—Overall financial statements Using financial.

Accounting and Financial Condition

Lecture 10 Outline• Overview

• Financial statements—pre-GASB 34.

• GASB 34—Overall financial statements

• Using financial statements to assess fiscal health.

Good Sources of Information on Accounting and GASB 34

• GASB Statement No. 34: Implementation Recommendations of School Districts. ASBO International, 2000.

• Dean Michael Mead. What You Should Know About Your School District’s Finances. GASB, 2000.

• SED. Reference Manual for Audits of General Purpose Financial Statements of New York State School Districts. SED, 2002. http://www.emsc.nysed.gov/mgtserv/for_those_districts_implementing%20GASB34%20.htm

• GASB. Guide to Implementation of GASB Statement 34 on Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments. GASB, 2000.

Overview of Government Aounting

• Financial management requires a common language, so that all parts of the government can be compared--that language is the governmental accounting system. It is the set of definitions and rules which guide the collection, categorization and reporting of financial data.

• The language of accounting can differ across organizations, but it can be difficult without training to detect the difference.

• It is important to understand the different types of accounting systems, their objectives, how data is recorded, and what financial information tells you about the organization’s finances.

Fundamental Equation of Accounting

• Assets = Liabilities + Fund Balance

• Assets – Liabilities = Fund Balance

• Change in Assets = Change in Liabilities + Revenues – Expenditures.

Accounting--Definitions

• Assets: What government owns.– Current assets: Assets that can be liquidated this year.

• Cash• Short-term investments• Accounts (and taxes and grants) receivable• Inventories.

– Non-current assets: Assets that are more permanent in nature.

• Capital assets not to be depreciated—land, facilities under construction.

• Capital assets that have depreciated: facilities, equipment.• Long-term financial investments.

Accounting--Definitions

• Liabilities: What government owes.– Current liabilities: will come due this year.

• Accounts payable• Deferred revenue• Short-term debt (BANs, TANs, RANS)• Due other funds or governments.

– Non-current liabilities:• Long-term debt• Compensated absences• Post-employment benefits• Due retirement systems• Judgments and claims payable

Accounting--Definitions

• Fund balance (net assets): Defined as the difference between assets and liabilities. Can be divided into:– Reserves for encumbrances– Other reserves (e.g., capital, repair, Worker’s

Compensation, Unemployment Insurance, debt service, insurance, etc.)

– Unrestricted, unreserved fund balance, which is available for any purpose.

Accounting--Definitions

• Revenues:– Property taxes– Other taxes– Charges for services– State revenues– Federal revenues.– One-time sales

Accounting--Definitions

• Expenditures (expenses): By function.– General support

– Instruction

– Pupil transportation

– Community service

– Employee benefits

– Debt service

– Capital outlay (depreciation)

– Cost of Sales

Expenditure Classification (accounting codes)

• NCES classification system:– Fund (1 digit)– Year (2 digits)– Function (4 digits)– Program (3 digits)– Object (3 digits)– Cost center (3 digits)—usually school.Example: 1 99 1000 100 610 105

Expenditure Classification (New York)

• New York uses a different classification system (ST3 form):– Fund: (1 digit), A=general, B=school store, C=food service,

F=special aid fund, H=capital projects, V=debt service.– Function (4 digit): 1000=general support, 2000=instruction,

5000=transportation, 7000=community services, 8000=civic activities, 9000=undistributed expenditures.

– Object (2 digits): .1=salaries, .2=equipment, .4=contractual, .45=materials and supplies, .49=BOCES, etc.

• Example: A2010.15General fund, instruction, supervision, instructional salaries.

ST3 is available at: http://stateaid.nysed.gov/st3_info.htm

Revenue Classification(accounting codes)

• New York system is very similar to NCES.– Fund (1 digit): same as expenditures

– Source (4 digits): 1000=local sources, 2000=revenue from other local governments, or from sales of property (overlaps with 1000), 3000=state aid, 4000=federal aid, 5000=other sources (interfund transfers).

• Example: A1001

General fund, real property taxes (excludes STAR revenue).

Measurement Focus

• The definition of what should be measured is called the measurement focus, and the issue of when transactions are recorded in the accounting system is the basis of accounting. – Accrual (business) accounting: Objective is to preserve equity of

the investors, which accountants refer to as a economic resource measurement focus.

– Modified accrual accounting: Objective is to assure financial control or accountability for general government functions, which implies a measurement focus on current financial resources.

Basis of Accounting

• Accrual: – Assets and liabilities: Under accrual accounting it is important to

report all assets and liabilities on the balance sheet. This implies that even long-term assets, such as buildings and equipment, should be added when acquired and long-term liabilities, such as debt, pension obligations, etc., should be reported as they are incurred (see Figure 10-1)

– Receipts and expenses: Receipts are recognized and recorded when they have been earned regardless of whether payment has been received. Accrual accounting recognizes expenses or the monetary value of resources used during the period to produce revenues when the resources have been used regardless of when the resources are paid for (Figure 10-1).

Basis of Accounting

• Modified Accrual:– Assets and liabilities: focus on those assets and liabilities, which

tend to be short-term in nature. This implies that modified accrual accounting focuses on current assets and current liabilities. (Figure 10-1).

– Revenues and expenditures: Revenues are recorded only when they are measurable and available. This implies for many taxes, such as the sales and income tax that they are recorded only when the cash is received. The term expenditures reflects commitments to pay for purchases of goods and services with current financial resources, not when resources are used. Therefore, the modified accrual basis is more conservative in its recording of revenues and expenditures (Figure 10-1).

FIGURE 10-1COMPARISON OF THE BASES OF ACCOUNTING

(1)

(2)

Accrual Basis Modified Accrual Basis A. Revenues and recorded when: Measurable (the amount Measurable (the amount

can be determined) and can be determined) and Earned (the service has Available (the revenue was been provided) collected in the current fiscal year or will be collected soon enough after the close of the fiscal year to pay liabilities of the current year)

B. Expenses/expenditures are (Expenses) (Expenditures)

Measurable (the amount Measurable (the amount can be determined) and can be determined) and Incurred (the liability Incurred (the liability has has been created) been created and will be paid from current resources)

C. Fixed assets are reported as: Assets in the fund Expenditures

where the purchase in the fund where the purchase is made and in the is made

statement of net assets D. Depreciation is reported: As an expense in the Not recorded fund owning the fixed

asset and in the statement of activities

E. The issuance of debt is As a liability in the fund As an “other financing source” reported: where the debt is issued on the operating statement. F. The repayment of debt is As a reduction of the As an operating expenditure. reported: liability G. Measurement focus used: Economic resources Current financial resources

Fund Accounting

• A crucial difference between public and private sector accounting is in the use of multiple funds in the public sector. Funds are separate fiscal and accounting entities used to record assets, liabilities, revenues and expenditures/expenses associated with certain government functions.

• Three types of funds:– Governmental funds: Used to record finances of general

government operations.– Proprietary funds: Used to record finances of government

“business” operations.– Fiduciary funds: Report assets that are held for others and that

cannot be used to support the government’s own programs.

Governmental Funds• a) General fund: The largest single fund in most governments is the "general fund". As

the name implies this is fund used to account for all revenues, expenditures, assets and liabilities not required to be reported somewhere else. Most general revenue sources go directly into the general fund and most of the current operations of government departments are recorded in this fund. In addition, there is a great deal of transfers between other governmental funds and the general fund.

• b) Special revenue fund: This is a fund used to account for special revenue sources which are earmarked for use for specific purposes. The most common in New York is a “special aid” fund that records transactions associated with categorical state and federal grants.

• c) Capital projects fund: This is used to account for the construction of capital projects to be used for general government operation, not for a special revenue group or public enterprise. For example, the construction of school buildings would generally be recorded under this fund. It receives its revenues from debt recorded in the "debt service fund" or general revenue sources from the general fund.

• d) Debt service fund: Is used to account for the long-term "general-obligation" debt committed by a community. In this fund would be recorded the payment of principal and interest. The revenues from these payments will generally come from the general fund.

• e) Permanent fund: Is used to record a permanent endowment provided the government. The endowment itself is not to be spent. Instead, interest payments from the endowment may be used.

* Accounting standard: Modified accrual.

Proprietary Funds

• a) Enterprise funds: Are used to account for agencies of the government, which produce a self-financing service for external customers. Examples might include a fund for school lunch, school store, and transportation. Since this is supposed to emulate a private firm, these funds are generally self-contained, including all debt, and capital construction transactions.

• b) Internal service fund: This is a parallel type of fund used to record transactions for a government agency which provides services to other government agencies. Examples might be a motor pool/repair department, computer support or a print shop. Other governments agencies are supposed to be charged the full cost of the service.

* Accounting standard: Accrual.

Fiduciary Funds

• Trust funds: are created to record resources the district is managing as a trustee. The district invests the funds, and may expend interest and principal.

• Agency funds: are created when the district acts as an agent to manage resources for another group (e.g., student and parent organizations).

*Accounting standard: Accrual.

FIGURE 10-2FUND ORGANIZATIONAL CHART

The Reporting Entity

A. Governmental Fund Types

1.General

2.Special

Revenue

3.CapitalProjects

4.Debt

Service

5.Permanent

B. Proprietary Fund Types

6.Enterprise

7.InternalService

C. Fiduciary Fund Types

Agency Employee Benefit Trust

InvestmentTrust

Private PurposeTrust

Financial Statements(Pre-GASB 34)

• Balance sheet: Measures the assets and liabilities at a given point in time (last day of the fiscal year). – For governmental funds, only current assets and

liabilities are recorded.

– For proprietary funds (and long-term fixed asset account group) will include property, plant and equipment as assets, and long-term bonds and capital leases as liabilities (also in long-term obligations account group).

Example of pre-GASB 34 CAFR for Cincinnati City School District: http://www.cpsboe.k12.oh.us/general/finances/2001CAFR.pdf

Financial Statements(Pre-GASB 34)

• Statement of revenue, expenditures and changes in fund balance: Records flows over the course of the year:– Revenues (receipts): additions to fund balance.– Expenditures (expenses): subtractions from fund

balance.– Fund balance at beginning of year and end of year:

difference is the surplus or deficit in this fund.* “Totals (Memorandum only)” indicates that the sum of

the three different types of funds should be viewed with caution, because of different accounting standards.

Example of pre-GASB 34 CAFR for Cincinnati City School District: http://www.cpsboe.k12.oh.us/general/finances/2001CAFR.pdf

Changes Under GASB 34• Management discussion and analysis section, which is meant to

provide a user friendly introduction and summary to the CAFR.• Government-wide financial reporting using an accrual basis of

accounting. Even financial data for “governmental funds,” which will continue to be reported using modified accrual accounting, will also be recast on an accrual basis so that picture of the financial position of the whole government can be determined.

• Government-wide financial reports will record for the first time all long-term assets (equipment, land, building, other infrastructure), and liabilities (long-term debt).

• Expenses that include consumption of capital assets (depreciation), rather than expenditures, which include the full cost of capital purchases in the year the purchases were made, will be reported on a government-wide basis.

• Two new financial statements will be required—The Statement of Net Assets, and Statement of Activities (discussed below).

Comprehensive Annual Financial Report (CAFR)

• Principal reporting of audited financial information to board of education, citizens, federal and state governments.

• Organized into 5 sections:– Introduction: Transmittal letter of auditor, letter from

independent auditor, organization of government, management discussion and analysis.

– Government wide financial statements.– Combined financial statements by fund type.– Notes to financial statements (see below).– Supplementary material, and statistical information.

· —

FIGURE 10-3- THE FINANCIAL REPORTING “PYRAMID”

(1) INTRO. SEC.,

AUDITOR LETTER, MGT. DISCUSSION

AND ANALYSIS

(2) GOVERNMENT-WIDE

FINANCIAL STATEMENTS (NET ASSETS, ACTIVITIES)

(3) COMBINED STATEMENTS BY FUND TYPE BALANCE SHEET, INCOME STATEMENT,

CASH FLOWS

(4)

INDIVIDUAL FUND AND ACCOUNT GROUP

STATEMENTS

(5)

SCHEDULES

(6) TRANSACTION DATA

(THE ACCOUNTING SYSTEM)

THE COMPREHENSIVE ANNUAL FINANCIAL REPORT (CAFR)

Government-wide Financial Statements

• Statement of Net Assets:– Assets: current assets, capital assets (can’t be depreciated), capital

assets that can be depreciated. Capital assets may be presented net of depreciation.

– Liabilities: current liabilities, and long-term liabilities due this year (or after this year), which include long-term debt, funds due to pension systems, uncompensated absences, benefits (health care) due employees after retirement.

– Net assets: Investment in capital assets net of related debt, restricted net assets, and unrestricted net assets.

See categories recommended by SED, and example for New York City (total government, not just school district).

Website for NYC CAFR: http://www.comptroller.nyc.gov/

Sample School DistrictStatement of Net Assets

June 30, 2002

ASSETSCash

UnrestrictedRestricted

InvestmentsUnrestrictedRestricted

ReceivablesTaxesState and Federal aidDue from other governmentsOther

InventoriesDeferred expendituresCapital assets, net

Total Assets

LIABILITIESPayables

Accounts payable $Accrued liabilitiesDue to other governmentsBond interest and matured bonds

Notes payableTax anticipationRevenue anticipationBond anticipation

Deferred creditsOverpayments and collections in advanceDeferred revenues - planned balanceDeferred revenues - other

Long-term liabilitiesDue and payable within one year

Bonds payableInstallment purchase debt payableDue to teachers' retirement systemDue to employees' retirement systemCompensated absences payable

Other postemployment benefits payableJudgments and claims payable

Due and payable after one yearBonds payableInstallment purchase debt payableDue to teachers' retirement systemDue to employees' retirement systemCompensated absences payable

Other postemployment benefits payableJudgments and claims payable

NET ASSETSInvestment in capital assets, net of related debt

Restricted for:EncumbrancesCapitalTax certiorari

Workers' Comp., Unemployment & InsuranceEmployee benefit accrued liability

InventorySubsequent year's expenditures

Unrestricted (deficit)

Total Net Assets -$

Government-wide Financial Statements

• Statement of activities: is a major change from the previous statement of revenues and expenditures. Includes information on:– Expenses (costs) by program or function (e.g., instruction), and

indirect expenses allocated to each function. Provides key information for cost analysis.

– Revenues associated with a particular program or function including charges and fees, and operating and capital grants.

– Net revenues by program.– General revenues, which fund multiple programs of the school

district.– Changes in net assets, net assets at the beginning and end of the

year.The difference between the net assets this year and last year is the surplus/deficit.

See categories recommended by SED, and example for New York City (total government, not just school district).

Sample School DistrictStatement of Activities

For the Year Ended June 30, 2002

Net (Expense)Indirect Program Revenues Revenue and

Expenses Charges for Operating Changes inExpenses Allocation Services Grants Net Assets

FUNCTIONS/PROGRAMSGeneral support $ $ $ $ - Instruction - Pupil transportation - Community service - Employee benefits - Debt service - Other expenses - School lunch program -

Total Functions and Programs -$ -$ -$ -$ -

GENERAL REVENUESReal property taxesOther tax itemsNonproperty taxesUse of money and propertySale of property and compensation for lossMiscellaneousInterfund revenueState sourcesFederal sourcesMedicaid reimbursement

Total General Revenues -

Change in Net Assets -

Total Net Assets - Beginning of year

Total Net Assets - End of year -$

Other Parts of CAFR

• Consolidated financial statements by type of fund: These are very similar in form to what these statements would look like before GASB 34. – Governmental funds: modified accrual– Proprietary funds: accrual– Fiduciary funds: accrual

Other Parts of CAFR• Notes (GASB 34):

– Note 1: Significant Accounting Policies—provides a description of the accounting system and some of the terminology.

– Note 2: Reconciliation of governmental fund statements and district-wide statements.

– Note 3: Changes in accounting principles.– Note 4: Stewardship and compliance with legal and contractual

provisions. Discusses actions to correct problems.– Note 5: Cash in financial institutions– Note 6: Participation in BOCES.– Note 7: ST investments at fair market value by type of investment.– Note 8: Capital assets balance and activity during year.– Note 9: Related party transactions.– Note 10: Short-term debt by type.– Note 11: Long-term debt and lease-purchase obligations.

Other Parts of CAFR• Note 12: Interfund balances and activity.• Note 13: Pension funds.• Note 14: Post-employment benefits (primarily health care for retirees.• Note 15: Risk management practices.• Note 16: Fund balances and reserve funds.• Note 17: Excess of actual expenditures over budget (budget variance

information).• Note 18: Donor restricted endowments.• Note 19: On-behalf-of payments (payments made to a 3rd party).• Note 20: Discretely presented component units (most districts won’t

have this.)• Note 21: Subsequent events (capital projects committed this year but

completed in future years.)• Note 22: Contingent liabilities: possible liability for returning grant

funds.For a full list and description of notes see: “Reference Manual for Audits of General Purpose FinancialStatements…” Appendix 3:http://www.emsc.nysed.gov/mgtserv/for_those_districts_implementing%20GASB34%20.htm

Other Parts of CAFR

• Supplemental information: Optional but very important to financial analysis of district.– Revenues and expenditures for last 10 years.– Assessed and equalized value of property for 10 years.– Debt ratios—see Lecture 13.– Demographic statistics.– Principal taxpayers—helps to identify how diverse

district revenue sources are.– Enrollment trends and projections.– Per pupil spending trends and comparison.

Using Financial Statements to Assess Fiscal Health

• “Sound fiscal health is imperative to the effective operation of municipalities in New York State. For this reason, local managers should periodically assess the financial condition of their local government.” Office of the State Comptroller, 2002.

• Audited financial statements provide one of the best sources of information to examine the financial condition of a government.

• Determining financial condition can be complex, but there are some simple indicators that can provide visibility on the fiscal health of district.

Defining Financial Condition

• “Financial condition may be defined as a local government’s ability to finance services on a continuing basis. This ability involves maintaining adequate service levels while surviving economic disruptions, being able to identify and adjust to long-term changes and anticipating future problems.” (NYS Comptroller, 1992, p. 1)

• Adequate service levels imply providing adequate resources so that students have the opportunity to reach Regents standards.

Overall Evaluation

LR Financial Condition

SR Financial ServiceLevel

Adequacy

FundBalance

Surplus/Deficits Liquidity

EconomicMeasures

DebtRatios

Financial Management

(based on survey)

FinancialFactors

Condition

DropoutRates

Other Exams

Regents Exams

Figure 10-4: Framework for Measuring Financial Condition

Framework for Financial Condition Indicator System

• Short-run financial condition: Ability to pay bills over the course of the year, balance the budget, and maintain adequate fund balance without extraordinary measures. Categories of indicators include:– Liquidity: Ability to pay bills.– Structural balance: Do revenues cover expenditures

without use of fiscal gimmicks?– Fund balance: Does district have adequate reserves to

cover financial emergencies?

Short-Run Financial Condition

• Liquidity:– Current assets/current liabilities (current ratio)

Rule of thumb: at least 1.25 to 1.5

Alternatives:– (Cash + current investments)/current liabilities

(quick ratio)

Rule of thumb: at least 0.5 to 1.0

Short-Run Financial Condition

• Operating Surplus (Deficit):– Total revenues-total expenditures in general fund

divided by total expenditures.Rules of thumb: should be positive. Deficits should be no

greater than 2% of total expend.Alternatives:– Same ratio for all funds (same criteria).– Short-term borrowing as percent of spending (RANs

and TANs)Rules of thumb: Look at trend. Use of ST debt should not

be going up as percent of budget.

Short-Run Financial Condition

• Fund Balance:– Unreserved, undesignated general fund

balance divided by GF expenditures.Rules of thumb: Nationally the standard of 5% is

often used. NY limits this percent to 2%.Alternatives:– Total general fund balance + selected reserves

divided by expenditures.Rules of thumb: should be between 3% and 5%.

ST Financial Condition--Example

• Current ratio (Figure 10-5): District 1 has had a current ratio below 1 for the last 6 years, while district 2 has had a ratio well above 2 in all years.

• Unreserved, undesignated GF balance as % of expend. (Figure 10-6): District 1 has had a declining fund balance, which has been negative for the last 7 years. District 2 has had a fund balance of 2% of spending.

• Surplus/deficit for GF as % of expend. (Figure 10-7): District 1 has been much more volatile with 5 years of deficit and 4 years of surplus. District 2 revenues and expenditures are about equal in most years with very low surpluses and deficits.

*Comparison suggests that District 1 is in financial trouble, while District 2 appears to have much more stable finances, and much stronger capability to withstand financial emergencies.

Figure 10-5: Current Ratio (Current Assets/Current Liabiliities)--A Tale of Two Districts

0.00

1.00

2.00

3.00

4.00

5.00

6.00

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Cu

rren

t R

atio

District 1

District 2

Figure 10-6: Unreserved, Unappropriated General Fund Balance as Percent of Expenditures

-16.00%

-14.00%

-12.00%

-10.00%

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

District 1

District 2

Figure 10-7: General Fund Surplus (Deficit) as Percent of Expenditures

-12.00%

-10.00%

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

District 1

District 2