"Chapter Two"

Cash basis, Accrual Basis & Fund Accounting

What are the major two basis of recording, explain the

advantages and disadvantages of each, and which base issued
in the governmental sector?
(A) Cash basis accounting: it's characteristics:
1- It recognizes only each inflows and outflows.
2- The resulting final accounts are nothing more than summarized cash
books.
3- There are no balance sheets, because there are no assets or liabilities.
4- Sales are only recognized, when cash is received (No receivable).

5- Purchases are only recognized, when cash is paid (No payables).

6- There are No stock adjustments.
7- There is No stock closing figure.

8- There are No fixed assets.

9- Cash basis accounting is practiced in many public sector and Not-
for-profit environment.

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- Advantages of cash basis accounting:
1) It's simplicity and the ease with which non-accountants can
understand and keep records on this basis.
2) It costs much less in terms of administration and accounting
expertise.

3) It doesn't include adjustments and also doesn't include their

subjectivity.

- Disadvantages of cash-basis accounting:

1) It provides information about capital, because there are no assets or
liabilities.

2) There is no opportunity to use an income figure in any way as a

comparative measure of business performance.
3) It provides no information about the cost of operating the
organization during the financial year.
4) If it's used by an organization that has substantial, unpaid bills or
uncollected revenues, the organization would have difficulty in
knowing where it actually stood.
5) It is useless and misleading for an organization to use a budget as a
control, technique under costs basis, since payment may for a long
time often incurring obligation.

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(B) Accrual basis accounting: it's characteristics:
1- Under the above base of accounting, revenues and expenses are
recognized, as they are earned or incurred not as money is received
or paid.
2- The earning of revenue is taken to mean, when invoices are issued.

3- Expenses are incurred, when services are received.

- Advantages of accrual basis of accounting:

1) Revenues and expenses in the income statement related to those
earned and those incurred respectively, (i.e.) much truer position is
shown than would be under cash basis accounting.

2) It yields a measure of capital.

3) It becomes the more appropriate basis when the organization has
substantial unpaid bills or uncollected revenue at the end of each
period and these amounts vary from period to period.
4) It is an essential requirement, if an organization is trying to evaluate
management performance or measuring the cost of a product or
service.

- The disadvantages of accrual basis of accounting:

1) It introduces subjectivity into the accounts.
2) Accrual adjustments demand a higher administrative and accounting
cost than cash flow accounting.

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- Fund accounting:
- It refers to the methods of accounting which reports in terms of
funds rather than in terms of organizations.
- A "fund" is a fiscal and accounting entity with a self balancing set of
accounts, segregated for the purpose of carrying on specific activities
or attaining certain objectives in accordance with special regulations,
restrictions or limitation.

As we said in chapter "one" that objective of Governmental accounting is

to support control and accountability over governmental units, so we can't
take governmental unit as one entity it will be very difficult to control, so
we can divide governmental unit into many units each called fund.
A) Fund: is physical and accounting entity that has a set of accounts
(Assets, liabilities and fund equity) to achieve a certain specific
objectives under regulations. As a result the accounting for any fund
will end with a balance sheet that include all fund assets, related
liabilities and fund Equity.

B/S of fund

Assets Liabilities
Fund Equity

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B) Accounting method "base" followed:
Accounting method is the timing at which the accounting should
recognize and record revenue and expense.

Business organization Non-Business organizations

(Follow GAAP under FASB) (Follow GAAP under GASB)

* Accounting method used is accrual We have three methods :

base. 1. Cash basis.
* (Revenue – Expense) = NI 2. Accrual basis.
* Sometimes we follow cash basis 3. Modified accrual basis
A) It we have small business:
Cash receipt – cash disbursement =
Net cash flow.
B) tax office also uses cash basis

(1) Cash basis:

* Under this method: The timing point in which we can recognize
revenue and expenses in the cash movement points.
* In this method, we recognize revenue when we collect cash and
expenses when we pay but the problem from following this
accounting method that it gives us a misleading information about
operational results.

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Example: Dec. 2007 received $ 10,000 down payment for work will be
made in June 2008.

Answer: If we follow cash basis we will record $ 10,000 as a revenue in

2007.
Dr Cr

Cash 10 000
Revenue 10 000

Although this revenue is related to year 2008 Not 2007, So the income
statement will be misleading as $10,000 revenue should be recorded in
the income statement of 2008 not 2007.

(2) Accrual basis:

- Under this method, we recognize and record revenue when it is
earned and recognize expenses when it is incurred.
Example One: In 2008, ABC company received $4,000 as a down
payment for work has to be performed in the future.

Date Exp. Dr. Cr.

Dec. 31,2008 Cash 4,000

Unearned revenue 4,000

-75% of work has been performed

Dec. 31, 2008 Unearned revenue 3,000

Revenue 3,000

-75% of work is performed

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Example Two: "x" Company provides a service of $ 300 to Mr. Smith
20/12/2008. He agreed to pay in 15/1/2001.

So, we record it as a revenue in 2000 not 2001 "Accrual".

Date Exp. Dr. Cr.

20/12/2000 A/R 300

Revenue 300

15/1/2001 Cash 300

A/R 300

We record it as a revenue in 2001 although it is related to 2000 as we

provide service in year 2000.
"Cash"

15/1/2001 Cash 300

Revenue 300

Example Three: 20/12/2000 incurred $150 rent expense but will not be
paid until 20/1/2001.

Under Accrual basis Under cash basis

20/12/2000, rent Exp. 150

A/P 150

20/1/2001, A/P 150 20/1/2001, rent Expense 150

Cash 150 Cash 150

So, expense recorded when it is So, we record expense in 2001

incurred in 2000. although it is related to year 2000.

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(3) Modified Accrual basis:
- Under this method to be near from accrual basis through:

Recognized of

Revenue & for Expenses

When it is Under modified accrual basis we've

Measurable → when we can state to replace term expense with term

& how much $ Available → Mean Expenditure.

already collected or expect to "We will recognize all expenses
collect soon when paid or incurred".
Expenditures include:
- All paid Expenses.

- incurred Expenses.
- repayment of loans.
- capital out lay.

Note:
According to modified accrual basis our statement will be statement of
revenues & expenditures and change in fund equity.

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 Summary
Cash basis Accrual basis Modified Accrual
basis
(A) Record Revenues
When cash is received When revenue is When revenue is
earned measurable and
available.
(B) Record Expense
or Expenditure:
When cash is paid When Expense is When Expenditure is
incurred. incurred

(C) Types of funds: In governmental units every resource is called fund.

Fund can be classified into 3 main categories.
(1) Governmental type fund:
This fund receives resources to expend it. (spending activity).
Note: Accounting for this fund depends on modified accrual basis.
Example: police department, fire department
Types of this fund: General fund, special revenue funds, capital project
fund (constructing a bridge), Debt service fund.

(2) Proprietary-type fund:

This type of funds aims to earn profit (capital maintenance try to
increase fund balance). Take fees against service.
Note: Accounting for this fund depends on accrual basis as we want to
compute net income.
Example, Metro.

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 Types of this fund:
A) International service funds:
Account for resources used to supply goods & services to
governmental units or within governmental units.
B) Enterprise fund:
Account for resources used to supply goods & services to
individuals outside governmental units.

(3) Fiduciary funds:

- It applies agency or trust relationship.
This type of fund can work either as :

Governmental type fund Proprietary type fund

Aim spending Aim profit (Capital maintenance)

Example:
(1) Agency fund: (1) Pension trust fund
Account for resources held by the Account for resources used for
government that must be disbursed government's employees retirement
according to law or contractual
agreement as social security
collection from employee wages.
(2) Expendable trust fund:
(2) Non expandable trust fund:
Account for resources not owned
Account for resources not owned
by the government but it has
by the government but it can invest
contractual responsibility to use
it.
within certain limits.

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(D) Comparing financial statement of business company & a
governmental unit:
(1) Governmental type fund:
In this fund we prepare :
(A) Balance sheet & (B) Statement of Revenues, expenditures and
changes in fund balance.
(A) Balance sheet of Balance sheet of business
Governmental type fund company

1. No subdivision of assets as 1. We classify assets into current

purchase of long-term assets is and long-term assets and also
considered as expenditure called we compute depreciation
capital outlay therefore we will
not record any depreciation (so
we consider all assets as
current).

2. No inventory as we provide 2. We have inventory to be sold to

services. customer.

3. No prepayment (prepaid) of 3. We have prepaid expenses as we

expenses as it will be considered follow accrual basis
expenditure.

4. Equity part is called fund 4. Equity consists of common stock

balance. R.E.

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 (B) Statement of Revenues, Income statement of business
Expenditures and change in fund company
balance

1. There are many sources of revenues. 1. Revenues mainly from

sales.

2. Objective not to achieve profit so 2. Net income is main

concept of net income is not used but objective so it exists.
statement is called statement of
revenue expenditure and change in
fund balance.

3. No depreciation expense as we do 3. We apply accrual basis so

considered purchase of long-term we have depreciation
assets as expenditure called capital Expense.
outlay.

4. No CGS as we don't have inventory. 4. We have CGS as we have

inventory.

5. Treatment of Equity 5. Treatment of Equity

Beg-fund balance. RE at Beg.
 Excess of revenue over expenditure + NI
 Transfer in (out)  Divided
End. Fund balance RE at End.
RE is reconciled in a separate
statement called RE statement

Note: Fund balance = Capital

Revenue = Revenue
Expenditure = Expense
Excess of revenue over expenditure = Net Income

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(5) General Fund-Balance Sheet Compared with Corporate
Balance Sheet:
City of New Example Cool Wheels Co., Inc.
General Fund Balance Sheet
Balance Sheet At December 31, 19X1
At December 31, 19X1
(A) Assets (A) Assets
Cash and investments $576,000 Current assets:
Receivables (net of allowances Cash and investments $50,000
for uncollectible accounts, Accounts receivable (net of
$3,000) (taxes) 89,000 allowance for uncollectible
Due from other funds accounts, $3,000) 135,000
(receivable) 50,000 Inventory 145,000
Total assets $715,000 Prepaid expenses 34,000
Total current assets 364,000

(B) Non-Current Assets

(B) Liabilities Property, plant, and equipment:
Accounts payable $123,000 Land 100,000
Due to other funds (payable) 75,000 Buildings (net of accumulated
depreciation, $55,000) 150,000
Accrued liabilities Equipment (net of accumulated
100,000
depreciation, $14,000)
Total liabilities 298,000 45,000
Total property, plant, and
equipment 295,000
(C) Fund balance Intangibles:
Fund balance (net resources Patents 30,000
that are available for use). 417,000 Total assets $689,000
Total liabilities and fund Liabilities:
balance $715,000 Current liabilities:
Accounts payable $35,000
Accrued expenses payable 55,000
Dividends payable 10,000
Total current liabilities: 100,000
Long-term, liabilities:
Bonds payable 300,000
Total liabilities: 400,000
Owner's Equity
Contributed capital 150,000
Retained earnings 139,000
Total owners' equity 289,000
Total liabilities and owners'
equity $689,000

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(6) General Fund-Statement of Revenue, Expenditures and
Changes in Fund Balance Compared:
City of New Example Cool Wheels Co., Inc.
General Fund Income Statement
Statement of Revenues, Expenditures, For the Year Ended December
and Changes in Fund Balance 19X1
For the Year Ended December 31, 19X1
Revenues Revenues
Income taxes $990,000 Net sales $988,000
Properly taxes 900,000 Other revenue 10,000
Licenses and permits 550,000 Total revenues 998,000
Fines and forfeits 250,000 Expenses
Miscellaneous 92,000 Cost of goods sold 450,000
Total revenues $2,782,000 Salaries expenses 280,000
Expenditures Depreciation expenses 175,000
Current Interest expenses 25,000
General government Expense 550,000 Other expenses 20,000
Public safety expense 990,000 Total expenses 950,000
Human services expense 780,000 Net income $480,000
Health expense 300,000
Recreation and parks 50,000
Capital outlay (to get a capital,
land, building, or repay a loan) 100,000
Total expenditures $2,770,000
Excess of revenues over
expenditures 12,000
(C) Other Financing Sources
(Uses)
+ Operating transfers in 50,000
- Operating transfers out (40,000)
Total other financing sources $10,000
Excess of revenues and other
financing sources over
expenditures and other
financing uses 22,000
Fund balance at beginning of
year. 395,000
Fund balance at end of year $417,000
End Fund Balance
= Beg. Fund Balance
 Excess of revenue over expenditures
 Transfer in
Transfer out
End balance
Note: Transfer in or out are transfer to a fund from other funds or Transfer from a fund to
other funds.

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(2) Proprietary – Type Fund
In this fund we prepare (1) Balance sheet.
(2) Income statement
Like any business entity.

(3) Fiduciary Fund

If

It is governmental type fund not It is proprietary type fund

Aim profit Aim profit
It must prepare: It must prepare:

1. Balance sheet. 1. Balance sheet.

2. Statement of revenues, 2. Income statement.
expenditures and changes in
fund balances

Examples
(1) Using the following data, prepare a statement of revenues,
expenditures, and changes in fund balance for the General Fund
of the Cairo City for the calendar year ended December 31,
19X1.
Miscellaneous revenues $ 360,000
Licenses and permits revenues 4,000,000
Expenditures for education 6,000,000
Expenditures for corrections 2,800,000
Operating transfers to other funds 3,000,000
Tax revenues 14,000,000

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 Expenditures for welfare 4,200,000
Federal grants 6,000,000
Expenditures for public safety 1,500,000
Expenditures for highways 1,800,000
Operating transfers from other funds 1,400,000
Fund balance of beginning of year 7,000,000

Statement of Revenues, Expenditures and Changes in fund Balance for

Dec. 31, 19X1
Revenues
Tax 14,000,000
Licenses 4,000,000
Grants 6,000,000
Miscellaneous Revenue 360,000
Total Revenue 24,360,000
Expenditures
Education 6,000,000
Correction 2,800,000
Welfares 4,200,000
Safety 1,500,000
Highway 1,800,000
Total Expenditures (16,300,000)
Excess of Revenue over Expenditures 8,060,000
+ Transfer from 1,400,000
(-) Transfer to (3,000,000)
Net change (1,600,000)
+ Beg. Fund balance 7,000,000
Ending fund balance 13,460,000

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(2) Record the following transactions On:
1. Cash basis.
2. Accrual basis.
Information:
Taxes receivable during the year is 70 millions L.E. of which 7.5
millions has been collected.
- During the year, the following transactions took place;
Exp. Paid Unpaid Total
1. Materials & Supplies 4 M. LE 150,000 4,150,000
2. Salaries & Wages 1 M. LE 250,000 1,250,000
3. Other exp 1.5 M LE 350,000 1,850,000

Solution
(a) Cash basis
Receipts 7,500,000
Less : Expenses
Materials & Supplies 4,000,000
Salaries & wages 1,000,000
Other expenses 1,500,000
Total expenses 6,500,000
Net Income 1,000,000

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(b) Accrual basis
Revenue 10,000,000
Less: Expenses
Materials & Supplies 4,150,000
Salaries & wages 1,250,000
Other expenses 1,850,000
Total expenses 7,250,000
Net Income 2,750,000

(3) Record the following transactions On:

1. Cash basis.
2. Accrual basis.
Information:
• Revenue LE 400,000 of which 380,000 has been received.
• Salaries expenses 240,000 of which 40,000 unpaid.
• Supplies purchased 50,000, paid only 40,000 where supplies or hand
are 10,000 LE
• Depreciation for building LE 10,000.
• Depreciation for cars LE 8,000.

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 Solution
(a) Cash basis
Receipts 380,000
Less : Expenses
Salaries exp. 200,000
Supplies exp. 40,000
Total expenses 240,000
Net Income 140,000

(b) Accrual basis

Revenue 400,000
Less : Expenses
Salaries exp. 240,000
(–) Supplies purchased 50,000
(–) Supplies on hand (10,000)
40,000
Dep. Exp. Bld. 10,000
Dep. Exp. Cars 8,000
Total dep. Exp. 18,000
Total expenses 298,000
Net Income LE102,000

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(4) Record the following transactions On:
1. Cash basis.
2. Accrual basis.
Information:
Taxes receivable during the year 20 millions L.E. of which 15 millions
has been collected.
- During the year, the following transactions took place.
Exp. Paid Unpaid Total
1. Materials & Supplies 8 M. LE 300 000 8,300,000
2. Salaries & Wages 2 M. LE 500 000 2,500,000
3. Other exp 3M LE 700 000 3,700,000
Solution
(a) Cash basis
Receipts 15,000,000
Less : Expenses
Materials and supplies. 8,000,000
Salaries and wages. 2,000,000
Other expenses 3,000,000
Total expenses 13,000,000
Net Income 2,000,000

(b) Accrual basis

Revenue 20,000,000
Less : Expenses
Materials & Supplies 8,300,000
Salaries & wages 2,500,000
Other expenses 3,700,000
Total expenses 14,500,000
Net Income 5,500,000

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(5) Record the following transactions On:
1. Cash basis.
2. Accrual basis.
Information:
- Revenue L.E. 200,000 of which 190,000 has been received.
- Salaries exp. L.E. 120,000 of which 20,000 unpaid.
- Supplies purchased L.E. 25,000 paid only L.E. 20,000 (supplies on
hand 5,000).
- Depreciation for building 5,000.
- Depreciation for cars 4,000.
Solution
(a) Cash basis
Receipts 190,000
Less : Expenses
Salaries exp. 100,000
Supplies exp. 20,000
Total expenses 120,000
Net Income L.E. 70,000

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(b) Accrual basis
Revenue 200,000
Less: Expenses
Salaries exp. 120,000
(–) Supplies purchased 25,000
(–) Supplies on hand (5,000)
20,000
Dep. Exp. Building 5,000
Dep. Exp. Cars 4,000
Total dep. Exp. 9,000
Total expenses 14,900
Net Income LE51,000

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 Case study

A dialog between 2 governmental accountant's:

Part One:
"A" says in our governmental unit we recognize all our revenues when
we collect.
"B" says I think you have to recognize your revenues when you provide
the service.
Answer
Both are mistaken
As (A) recognize revenue under cash basis.
while (B) recognize revenue under accrual basis.
while GASB require to follow modified Accrual basis.

Part Two:
(A) In our governmental unit we follow a fund accounting Approach that
must start with recording all budgeted amounts for next year.
(B) Yes, you are correct.
Answer
I disagree with both a fund accounting cycle start with preparing the
budget first.

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Part Three:
"A" in our governmental unit we open three permanent accounts which
are cash, A/R, investment for open four temporary accounts which
are : (1) Estimated revenue. (2) Unreserved fund books
(3) Revenue. (4) Expenditure
"B" I think part one is all, but Part Two you have to say Appropriation
not unreserved fund balance.
Answer
Agree will B and don't agree with "A".

Part Four:
"A" Governmental Accounting we follow GAAP issued by GASB.
"B" You are correct.
Answer
I Agree with A & B.

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