Chapter 5 Recognizing Expenditures in Governmental Funds Chapter 5 Granof & Khumawala-6e 1.

Chapter 5Recognizing Expenditures in Governmental Funds

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Thought to Ponder: Chapter 5

The same prudence which in private life would forbid our paying our own money for unexplained projects, forbids it in the dispensation of public moneys.

President Thomas Jefferson Cha

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Learning Objectives

• Modified accrual basis

• Full accrual basis

• Accounting for different expenditures

• Types of interfund activities and how they are reported

• Other Financing Sources and Uses

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Financial Statements

Two types of financial statements:•Governmental Fund financial statements o Basis of Accounting: Modified accrual basis

o Provides information relating to Inter-period equity

•Government-wide F.S.o Basis of Accounting: Full accrual basiso Presents revenues and expenses from the perspective of the

entity as a whole and not of the individual funds.

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GAAP

• GASB Codification, paragraphs 1600.102 through 1600.105.

• The Codification asserts that the “accrual basis is the superior method of accounting for the economic resources of any organization,” and states that the “use of the accrual basis to the fullest extent practicable is recommended.”

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Governmental Fund Statements

• Required Financial StatementsoBalance sheet

presents the fund’s resources at a particular point in time.

oOperating statementpresents the net change in resources during a

particular period of time.

• Basis of Accountingo Modified accrual basis

• All measurements are in accordance with GAAP.

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Modified Accrual Accounting

Criteria : Measurable and Available• Measurable : Government is able to determine or

reasonably estimate the amount.

• Available : Collectible within the current period or soon enough thereafter to be used to pay liabilities of the current period.

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Expenditures vs. Expenses

Expenditures • Definition: “measure of fund liabilities liquidated with current

resources”• Decreases net current financial resources (i.e. Fund Net

Assets)• Used in Modified Accrual Basis

-- i.e. Fund Financial Statements

Expenses • Definition: “measure of costs expired or consumed during a

period”• Reduction in net economic resources (overall net assets)• Used in Full Accrual Basis

-- i.e. Government-wide Statements

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Expenditures

• Closely tied to cash flows and near-cash flows

• Governmental funds report only current liabilities and not long-term liabilities.

• Expenditures recognized when cash is paid or fund liability accrued* for goods/services received.

* next slide . . .

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. . . liability accrued*• “Revised” Expenditure Definition: o Decreases in net current financial resources (i.e. Fund Net

Assets) NOT resulting from transfers (and refunding transactions)

• NORM – Recognize when FUND Liability is incurredo Exceptions include: Materials, Supplies, and Prepaid Items

Recognize based on either Purchases or Consumption Basis

o Debt Service Expenditures on Government Long Term Debt Recognize when Legally Due

o Pensions, Claims and Judgments, Compensated AbsencesRecognize when Payable from Available Expendable

Financial Resourceso Capital Leases

Recognize based on Substance vs. Form Basis

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Salaries and Wages

• May be earned in one fiscal year but paid in the next

• Recognize the expenditure in the period in which it is earned by the employee (provided the government’s obligation will be liquidated with expendable available financial resources.)

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Governmental fund vs. for-profit (full accrual) payroll accounting• similar, except expenditures, not expenses are recorded.

Example: Wages and related benefits of employees for the last pay period in December 2013 were $40 million. Employees are to be paid on January 6, 2014. The fiscal year ends December 31.

General Fund Dr. Cr.

Wages and benefits expenditures $40M

Accrued wages payable 40M

Government-wide: same (except for “expense” label).

Remember, no entries are made under government-wide. There is only a conversion done on the Working Papers at the end of the year.

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Example 1

Dr. Expenditures (for the full amount of payroll) • Cr. Liabilities (for withholdings from employees pay)• Cr. Cash for the amount paid to employees

Timbaktu City recognized its payroll for the most recent two week pay period for employees paid from the General Fund.

GF General Journal Dr. Cr.

Expenditures--2013 948,000

Due to Federal Gov’t 86,000

Due to State Gov’t 49,000

Cash 713,000

The Subsidiary Ledger provides the details of the total expenditure as follows:

General Government 178,000

Public Safety 480,000

Public Works 290,000

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Example 2

Dr. expenditures for the employer’s payroll costs (including employer’s share of FICA)

Cr. Liability to federal government.

GF General Journal Dr. Cr.

Expenditures--2013 188,000

Due to Federal Gov’t. 188,000

Expenditures Subsidiary Ledger:

Contributions for Retirement 188,000

Encumbrances usually are not recorded for recurring

expenditures such as payroll.

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Salaries and Wages (cont’d.)

Governments Vs. Business

7 Major differences

1) Compensated absences (Ch. 5 & 8)

2) Pension accounting (Ch. 10)

3) Claims and Judgments (Ch. 8)

4) Inventory accounting (Ch. 5)

5) Prepayments (Ch. 5)

6) Accounting for capital assets (Chs. 6 & 7)

7) Accounting for interest and principal (Chs. 6 & 8)

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(1) Compensated Absences (CA) Overview

• Earned in one period but often not paid until several periods later (i.e. It’s not current.)

• Amount to be paid is often uncertain. o Compensation is based on the salary/wage rate in effect

when the time off is taken.

• GASB standard:o Vacation leave and compensated absences should be

accrued as a liability as the benefits are earned if BOTH the following conditions are met:Attributable to services already rendered and Probable that compensation will occur (paid time off or

other means)

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(1) Vacation Leave

• Vacation pay expenditures and related fund liabilities should be recognized in the periods in which they are due.

Until those periods, those liabilities are reported ONLY in the schedule of long-term obligations.

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Example 1-a

Example: City employees earned $300,000 in vacation leave they did not take in 2013. The leave vests and can be taken at any time up to retirement.

•No entry in the governmental funds

Government-wide: (no real entry here either)

But this will be the conversion at year end. Dr. Cr.

Vacation pay expense 300,000 Accrued vacation payable 300,000

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Example 1-b

Example: City employees earn $8 million in vacation leave. Of this amount, they are paid $6 million in 2010 and defer the balance until future years.

Governmental fund DR CRVacation pay expenditure $6M

Cash (or Wages Payable) $6M

The $2 million deferred until future periods should be reported in a schedule of long-term obligations.

Government-wide statements (no real entry here either).

But this will be the conversion at year end. DR CR

Vacation Pay expense $8MCash (or Wages Payable) $6MAccrued Vacation Pay 2M

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(2) Sick Leave

• Beyond the control of both the employee and the employer.

• GASB states that sick leave is recognized as a liability only if it is probable that the employer will compensate the employees for the benefits through cash payments conditioned on the employees’ termination or retirement.

• It should be recorded ONLY when expected to be paid to employees upon their resignation or retirement.

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Example 2-aExample: City employees earned $170,000 in sick leave but were

only paid for $140,000. The leave accumulates but does not vest.

Governmental fund DR CRSick leave expenditure $140,000

Cash $140,000 The city will not have to compensate employees for leave not

taken as a termination benefit. It should charge as an expenditure only the amount that was liquidated with expendable financial resources. It need not report a liability even in the schedule of long-term obligations.

Government-wide*: Same rules apply. Only the $140,000 paid needs to be charged as an expense.

*No actual journal entry is made. But this will be the conversion at year end.

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Example 2-bExample: A city pays for its employees’ unused sick leave up to thirty days only if they terminate at least after 10 years of service. In 2013, the city had the following estimates: •Sick leave earned = $12 mil; •Payments in the future to employees = $8 mil•Payments to 10-year employees upon termination = $1mil•Amount that will not be paid = $3 milGovernmental fund:

No entry is required. The city recognizes a liability only for the $1 million to be paid in termination benefits. Assuming that those termination benefits are not paid in the current year, it is recognized in the schedule of long-term obligations

Government-wide: (again no actual journal entry is made)

DR CRSick leave termination benefit expense $1M

Accrued Sick Leave 1M

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(3) Sabbatical Leave• After a specified term of service, employees may be

granted a paid leave.• They are offered to benefit both the employee and

the employer in the future, not the past. • The employees are required to perform other

activities that will enhance their job-related abilities during their time off.

• GASB standard: o Accounting depends on the purpose of the leave

Activities to enhance their job-related skills--Account for in the period the leave is taken

“Compensated unrestricted time off” --Liability is accrued during the period the leave is earned.

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Example 3-a

City teachers are entitled to sabbatical leaves of six months every 7 years for research and renewal. The 2013 share of leave costs to be taken in the future was $300,000.

Governmental Fund: • Sabbatical leaves need not be recognized as a liability if it is

a reward for past service (i.e. it is for unrestricted time off). • It need not be accrued if it constitutes merely a change in

assigned duties (e.g. research instead of teaching).

Government-wide: • Same.

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Pensions Overview (Ch 10)

Definition: Amount of money paid to retired or disabled employees.•If the Government makes the required contribution to the pensions in full

-- amount recorded = amount of contribution.•GASB Standard:oThe expenditure should be the amount that will be liquidated with expendable available financial resources.

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Claims and Judgments (CJ) Overview (Ch 8)

• GASB Std. #10, Claims and Judgements, para. 53. (also FASB Std. # 5)o Liability accrued if:

Probable that Asset Impaired/Liability Incurred by Balance Sheet date

Loss can be reasonably estimated• Expenditure amount: o Recognize in the governmental fund only the portion of

liability that is normally to be Liquidated with Available Expendable Financial Resources

o Liability recorded at “face value.”• Balance of liability is in the Schedule of LT Obligations – o No expenditure recognizedo Expense is recognized in the government-wide statements

at the time the loss liability first satisfies the FASB No. 5 criteria. (probable and estimatable)

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Are not expendable available financial resources.

• Unlike businesses, governments do not acquire inventories with the intention to resell them. o Instead, they use it to carry out day-to-day

operations.• Two Primary issues pertaining to governmental funds

are:o Timing of the expenditureo Reporting of the assets

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(4) Materials and Supplies--Overview

Overview (cont’d)

Accounting for Inventory• Two methods of accounting availableoConsumption MethodoPurchases Method

• Each method assumes periodic rather than perpetual inventory accounting

• All purchases are debited to Expenditures

• The Inventory of Supplies account is updated at year-end as an adjusting entry

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Consumption Method. Assume the following data:

Beginning inventory $ 20,000

Purchases during year 150,000

Available for use 170,000

Ending inventory (15,000)

Amount consumed $155,000

Adjusting Journal Entries: Dr. Cr.

Expenditures--2010 $5,000

Inventory of Supplies 5,000

Fund Balance - Reserved for Inventories 5,000

Fund Balance – nonspendable 5,000

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Example 1 – Consumption Method

Purchases Method. Assuming the same data:Beginning inventory $ 20,000Purchases during year 150,000Available for use 170,000Ending inventory (15,000)Amount consumed $155,000

Adjusting Journal Entries: Dr. Cr.Fund Balance-nonspendable $5,000

Inventory of Supplies 5,000(Note that the Expenditures account is not affected by the adjusting entry)

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Example 2 – Purchases Method

Materials and Supplies (cont’d)

Government-wide statements: Should be reported on a consumption basis.

Supplies expense (not expenditure) would be debited.

No need for inventory reserve.

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Example 3 In 2013 the City ordered supplies that cost $4 million, received

supplies that cost $3.5 million, paid for supplies that cost $3 million and used supplies that cost $3.3 million.

Common Entries*: Dr. Cr.

Encumbrances $4

Reserve for encumbrances $4

Reserve for encumbrances $3.5

Encumbrances $3.5

Accounts Payable $3

Cash $3

* Common under both Consumption and Purchases method

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Example 3 (cont’d)

Purchases method: DR CR Supplies expenditure $3.5

Accounts Payable $3.5Supplies inventory $0.2

Fund balance-nonspendable $0.2

Consumption method:Supplies Inventory $3.5

Accounts payable $3.5 Supplies expense $3.3

Supplies Inventory $3.3Fund balance (unassigned) $0.2

Fund balance -nonspendable $0.2

Government-wide: Must use consumption method.

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(5) Prepayments: Overview

GASB standards:• Fund Statements:o Either purchases or consumption method can be used

• Government-wide statements: o Only consumption method must be used

• If services extend over more than one accounting period o Need not be allocated between or among accounting periodso GASB does not distinguish between current and long-term

prepayments.--i.e. the unused portion of insurance policy for two or more

years would be reported as an asset – the same as a one-year policy

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Example 1

On June 15, 2013 the city acquired and paid for an insurancepolicy that cost $300,000. The policy covers the two-year period

beginning July 1.

Purchases method: DR CRInsurance expenditure $300

Cash $300

Consumption method:Prepaid insurance $300

Cash $300

Government-wide: Must use consumption method.

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Capital Assets Overview (Ch 6)

Provide services in periods beyond those in which they are acquired.

GASB standards:General capital assets – are not specifically related to activities

that are reported in proprietary or fiduciary funds.General capital assets are neither reported on governmental

fund balance sheets nor depreciated on governmental fund statements of revenues, expenditures, and changes in fund balance.

Governments reports general capital assets in the period requiring the outflow of expendable available financial resources.

Accounting for capital assetsFund Statements

--Expenditure as purchasedGovernment-wide statements

--Capitalize and Depreciate (like business)

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Example 1

The city acquired a computer system for all its departments at a cost of $3 million, and paid in cash. It has a useful life of three years.

General Fund: DR CRExpenditure-acquisition of capital assets $3

Cash $3

Government-wide*: Would capitalize and depreciate*This is not a real entry but conversion is made at the end of the

year.

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(7) Interest and Principal on Long-term Debt: Overview

Principle:• Recorded in schedule of long-term obligations.• If a principal repayment extends beyond a fiscal

year, expenditures are recognized entirely in the year the payments are due.

Interest:• Major expenditure for many governments.• Source of payments are either general revenues

or revenues dedicated for debt service revenues.• The government transfers cash from general fund

as payments are made.

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Nonexchange Expenditures: Overview

GASB Standards (applicable to both modified and full accrual statements):

• Nonexchange expenditures o Should generally be recognized with their revenue

counterparts -- (i.e.) when the recipient of the grant has satisfied all eligibility requirements.

• Nonexchange expenseso Grants would be recognized as expenses in the same period

in the government-wide as in the fund statements.

• Modified accrual statementso Revenues must be available for expenditure before they can

be recognized.

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Example 1

Example: In December 2013, the city approves a $300,000 grant to a not-for profit health clinic. The funds are to be paid in 2014 out of funds budgeted for that year and are intended to support the clinic’s activities in 2014.

General Fund: In as much as the clinic cannot use the funds until 2014, the grant is subject to a time requirement. The clinic need not recognize either a liability or an expenditure until 2014, when the time requirement is satisfied.

Government-wide: Same.

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Example 2

Example: In Dec. 2013 the city awards a not-for profit clinic $400,000 for the acquisition of emergency communications equipment. Payment is made at the time the award is announced. The clinic is permitted to use the funds upon receipt, but intends to use them in 2014.

--Purpose restrictions have no impact on the timing of either

expenditure or revenue recognition. The state must recognize an expenditure as soon as it expends the funds and the county is eligible to spend them:

Governmental Fund: Grant expenditure $400,000

Cash $400,000

Government-wide*: Same, but expense instead of expenditure. * This is not a real entry but conversion is made at the end of the

year.

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Example 3

Example: In Dec. 2013, the city awards a not-for profit $200,000 for the acquisition of emergency communications equipment. The grant is to be paid as the organization incurs and documents allowable costs. In 2014 the organization submits claims for $150,000 of which the city pays $125,000. The city expects to pay the $25,000 balance of claims submitted in Jan 2015 and the $50,000 balance of the grant by June 2015.

--- The not-for- profit is eligible for the award only as it incurs and documents allowable costs. In 2014, the city became eligible for $150,000 of the grant—the amount that the state should recognize as an expenditure.

General Fund: Grant expenditure$150,000

Cash $125,000Grants payable 25,000

Government-wide*: Same, but expense instead of expenditure. * This is not a real entry but conversion is made at the end of the

year.

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Assume a grant of $100,000 is received at the beginning of the fiscal year from the federal government to operate a counseling program for troubled youths.

The entry in the special revenue fund is: Dr. Cr.

Cash $100,000 Deferred Revenue $100,000

Explanation: Until eligibility requirements for the grant have been met by incurring expenditures for the intended purpose, an “exchange transaction” it is reported as “Deferred Revenue” (a liability).

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Example 4

Assume that during the year the Counseling Program expended $75,000 for costs related to youth counseling, thus meeting the eligibility requirement to expend grant resources. The entries would be:

Dr. Cr.

Expenditures $75,000

Vouchers Payable $75,000

Deferred Revenues $75,000

Revenues $75,000

(This amount would also be recorded in the Revenue detail account in the Revenue subsidiary ledger).

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Example 4 (cont’d)

Interfund Transfers (Ch. 6-9)

Two types of interfund activity:

(a) Reciprocal: Equivalent of exchange transactions

(b) Nonreciprocal: Equivalent of nonexchange transactions.

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Summary• Accrual basis recommended to the fullest extent

practicable. • 2 criteria must be met before revenues are recognized

in governmental funds:oResources must be Measurable andoAvailable

• Governmental fund expenditures are defined as decreases in net financial resources.

• Expenses are outflows or consumption of overall net assets.

• Nonexchange transactions in the governmental fund are accounted for symmetrically to nonexchange revenues.

• Grants are recognized as expenditures when all the requirements are met.

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