Solution Manual for Governmental and Nonprofit

Accounting 10th Edition by Freeman

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Solution Manual for Governmental and Nonprofit Accounting 10th Edition by Freeman

CHAPTER 11
INTERNAL SERVICE FUNDS

ANSWERS TO QUESTIONS

Question 11-1

Among the advantages to the unit establishing such an Internal Service Fund are the following:

1. Centralized purchasing. Centralized purchasing might permit a more qualified

purchasing agent to be employed; lead to the acquisition of better goods for the same
price or goods of equal quality to those now being acquired at a lower price; result in
better control of quantities ordered; increase both the quantity discounts received and
the purchase discounts taken by buying in larger units and in planned order sizes and by
improving purchase discount control; reduce the number of purchase orders that have to
be processed; etc.

2. Central storeroom. A central storeroom might lead to better assessment of purchasing

needs; less obsolete inventory; less total investment in inventory, through avoiding
duplication of inventory items in several departments; better control over theft and other
causes of inventory shrinkage; improved inventory costing, both within the Internal
Service Fund and with regard to amounts charged to the various departments; fewer
out-of-stock delays; etc.

Question 11-2

Many benefits should accrue as a result of costing the activities financed through an Internal
Service Fund, including:

1. The knowledge of what a good or service costs is provided, as well as the ability to
compare the cost of the goods or services provided through the Internal Service (IS)
Fund with that of similar goods or services provided commercially. In this sense it
serves both to enhance general knowledge and as a control over the IS activity to ensure
that it does not price its goods or services above the market price of similar ones.
2. Related to the first, it should facilitate more intelligent "make or buy" decisions at all
levels.
3. It helps create a "cost conscious" attitude among employees at all levels and thereby
encourages economy and efficiency of governmental management.
4. The ability, over time, to observe cost trends and changes therein permits one to better
manage and evaluate management of the IS activity.
5. It enhances the ability to distribute costs of IS activities equitably among user
departments.

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Question 11-3

The level of activity—and hence the expenditure requirements and revenues—of an Internal
Service Fund are determined by the demands of the user departments for its services. Hence, the
Internal Service Fund should not normally be constrained to fixed budget limitations that might
hamper its ability to fulfill its service functions—but should be budgeted on a flexible basis.
Furthermore, the appropriations made for the user departments serve as an indirect budgetary
ceiling on the Internal Service Fund, making formal budgetary control on a fixed basis less
essential for the Internal Service Fund than for the expendable funds through which the
departments served by the Internal Service Fund activity are financed.

Question 11-4

Internal Service Funds are required to be reported by fund type in the basic financial statements.
This means that only one column for Internal Service Funds is reported on the proprietary funds
statement of net position, the statement of revenues, expenses, and changes in net position, and
the statement of cash flows regardless of how many internal service funds are maintained by the
governmental entity. It is a combined column. For governments that prepare a Comprehensive
Annual Financial Report, combining financial statements are required in the supplemental
statements and schedules if the government has more than one Internal Service Fund.

Question 11-5

The original capital required to establish an Internal Service Fund may be acquired in a variety of
ways:

1. Transfers from the General Fund or other funds of the governmental unit.

2. Advances from the General Fund or other funds. Because an advance is temporary,
presumably Internal Service Fund rates would be established somewhat higher than cost
in order to repay the advance. In this case, reported user fund expenditures/expenses of
future years will be higher than cost (or there will be transfers) to build up the capital of
the Internal Service Fund. Precautions must be taken to assure that this practice is not
abusive and does not result in unallowable costs being charged to grants, etc.

3. Proceeds of bond issues or other debt instruments may be used to provide either
permanent or temporary capital.

4. Transfer of existing equipment, inventory, and the like from other funds or from general
capital assets.

5. Grants or advances from other governmental units.

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Question 11-6

Direct cost of goods or services provided, with no provision being made for items such as
depreciation or overhead, would be appropriate as the basis for Internal Service Fund
reimbursement when (1) such other costs (other than direct costs) are immaterial, as where an
Internal Service Fund entity is used merely to distribute common costs (such as telephone or
two-way radio facility services) equitably among the various user departments—and is in
essence a "flow through" or "clearance" device; and (2) when such costs as salary or other
overhead are being financed through separate departmental appropriations and it is the intent that
neither these nor depreciation and similar costs be recovered through Internal Service Fund
charges. Those cases falling within the latter category must be evaluated carefully to assure that
the intent and the resultant fee structure are indeed appropriate. But so long as the intent of the
governing board is indicated, the reimbursement rates and Internal Service Fund accounting must
be consistent with the intent of the governing body.

Question 11-7

The change in the net position balance of an Internal Service Fund that is intended to break even
may be disposed of as follows:

1. If the intent is that it break even each year, then the change in net position (positive or
negative) would be disposed of through supplemental billings to, or issuance of credit
memos to, the user departments on an equitable basis.

2. If the intent is for the Internal Service Fund to break even over a span of several years,
the results of a particular year being considered of lesser consequence, the change in net
position would be closed to Net Position. The causes of the change in net position
should be examined to see if they indicate that the rate at which Internal Service Fund
activities are billed to user departments should be adjusted.

Question 11-8

Accounting for an Internal Service Fund that is controlled by a fixed budget is often called
"double accounting" if a dual budgetary and proprietary accounting system is used in which (1) a
single transaction often necessitates that both budgetary and proprietary entries be made, while
(2) other transactions or events require entries in only one or the other type of accounts.

Question 11-9

a. If the bonds are still outstanding, at least the cash and near cash items (such as investments
and receivables) typically should be transferred to the Debt Service Fund which will retire
the bonds. If the other assets are sold, the proceeds should be placed in the Debt Service
Fund. If the other assets are to be used by a proprietary fund, the assets should be
transferred to that fund; if the assets are to be used by a governmental fund, the assets should
be recorded in the General Capital Assets and General Long-Term Liabilities accounts. In
both of the latter cases it is preferable that cash in the amount of their fair value be
transferred to the Debt Service Fund.

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Question 11-9 (continued)

b. If the bonds are no longer outstanding, the Internal Service Fund assets may be disposed of
as the governing body sees fit. Capital assets should be recorded in proprietary funds or in
the General Capital Assets and General Long-Term Liabilities accounts, as appropriate.

Question 11-10

One approach to pricing Internal Service Fund goods or services is to estimate the total costs
expected to be incurred and the total quantity of goods or services expected to be required by
user departments or agencies. A predetermined rate is determined based upon this information.

A second approach is to charge the departments or agencies based on actual costs determined at
the end of each month, quarter, or year. The limitations and problems associated with this
pricing method are discussed in the answer to Question 11-6.

Question 11-11

Centralized risk financing activities are required to be accounted for through the General Fund, a
Special Revenue Fund, or in an Internal Service Fund.

Question 11-12

While there are various reasons that some governments charge more than historical cost for
Internal Fund Services in order to build up the level of net position, one of the most
understandable is that the replacement cost of assets is often significantly greater than their
historical cost. (Some governments base their Internal Service Fund billings on replacement cost
estimates as a mechanism for financing replacement of existing assets at the expected higher
costs). While it is prudent for management to be concerned about this issue, there are financial
reporting concerns and legality issues that are important to understand.

From a financial reporting standpoint, the billings to departments in excess of historical costs
should technically be reported as transfers. From a legality standpoint, overcharging user
departments sometimes results in diverting restricted resources to other purposes. The practice
may result in the illegal use of intergovernmental grant or other restricted resources. Internal
Service Fund charges (included in expenditures submitted for grant reimbursements) are watched
closely by federal auditors.

Question 11-13

Governments with more than one Internal Service Fund must present Internal Service Fund
combining financial statements in their Comprehensive Annual Financial Reports. These
combining financial statements are reported in the combining and individual funds financial
statements in the financial section.

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Question 11-14

The required financial statements for an Internal Service Fund are:

• Balance sheet (Statement of net position)
• Statement of revenues, expenses, and changes in net position
• Statement of cash flows

SOLUTIONS TO EXERCISES

Exercise 11-1

1. c
2. d
3. b
4. d
5. c
6. c
7. b
8. c
9. d
10. a

Exercise 11-2

1. b
2. d
3. d
4. c
5. b
6. c
7. d
8. b
9. d
10. b

Exercise 11-3

1. Salaries Expense ............................................................ 10,300

Cash ........................................................................ 10,000
Accrued Salaries Payable ....................................... 300
To record salary payments and accruals.

2. Equipment ...................................................................... 50,000

Cash ........................................................................ 5,000
Notes Payable—Long-Term ................................... 45,000
To record purchase of equipment using note.
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Exercise 11-3 (continued)

3. Due from Other Funds ................................................... 10,000

Cash................................................................................ 90,000
Revenues—Billings to Departments....................... 100,000
To record sales and collections.

4. Losses—Claims and Judgments .................................... 25,000

Claims and Judgments Liabilities—Long-Term .... 25,000
To record contingent loss.

5. No entry.

6a. Inventory of Supplies ..................................................... 41,000

Vouchers Payable ................................................... 41,000
To record purchase of supplies.

6b. Vouchers Payable........................................................... 41,000

Cash ........................................................................ 41,000
To record payment of vouchers.

7. Supplies Expense ........................................................... 25,000

Inventory of Supplies .............................................. 25,000
To record use of supplies.

8. Depreciation Expense—Equipment ............................... 16,000

Depreciation Expense—Buildings ................................. 25,000
Accumulated Depreciation—Equipment ................ 16,000
Accumulated Depreciation—Buildings .................. 25,000
To record depreciation.

9. Interest Expense ($45,000 x .1 x .75)* .......................... 3,375

Interest Payable ....................................................... 3,375
To record interest on note.

10. Cash................................................................................ 10,000

Accumulated Depreciation—Equipment ....................... 21,000
Equipment ............................................................... 28,000
Gain on Sale of Equipment ..................................... 3,000
To record sale of equipment.

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SOLUTIONS TO PROBLEMS

Problem 11-1

1. c
2. e—Must know if transfer was made to defray capital asset costs.
3. a
4. c
5. c
6. a
7. d
8. b
9. b
10. b—Assumes that the short-term borrowing is that referred to in #9.

Problem 11-2 (a)

Sorensen County Self-Insurance Fund Entries

1. Cash ....................................................................................... 2,000,000

Transfer from General Fund .......................................... 2,000,000
To record transfer in to establish the Self-Insurance
Fund.

2. Cash ....................................................................................... 105,500

Billings to Departments ................................................. 90,000
Revenues Collected in Advance .................................... 15,500
To record collections of required current year
contributions and of the Enterprise Fund
prepayment of next year's contribution.

3. Administrative Expenses ...................................................... 3,600

Administrative Expenses Payable .................................. 3,600
To record administrative expenses.

4. Expenses—Claims and Judgments ....................................... 42,000

Cash ............................................................................... 42,000
To record settlement of claims filed (and paid)
during the year.

5. Expenses—Claims and Judgments ....................................... 36,000

Liability for Claims and Judgments—Current .............. 22,000
Liability for Claims and Judgments—Long-Term ........ 14,000
To accrue probable losses at year end.

Note: The $4,200 of reasonably likely losses do not meet the probability criterion for accrual.
They should be disclosed in the notes to the financial statements.

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Problem 11-2 (b) (continued)

If there were no Self-Insurance ISF and all of the claims related to the Central Printing ISF,
entries 4 and 5 would be recorded in the Central Printing ISF. (If other proprietary funds were
responsible for some of the claims, the appropriate portions of the losses and liabilities would be
recorded in those funds. If general government departments were responsible for the claims,
only the settled or due and payable amounts would be recorded in the governmental funds. The
long-term portion of the liability would be reported in the GCA-GLTL accounts and reported
only in the government-wide financial statements.)

Problem 11-3 (a)

Journal Entries

(1) Due from General Fund ........................................................... 36,000

Billings for Services ......................................................... 36,000
To record billing for printing 30,000 brochures for
the Publicity Bureau.

(2) Supplies Inventory ................................................................... 13,000

Accounts Payable ............................................................. 13,000
To record purchase of supplies on account.

(3) Salary Expense ......................................................................... 30,000

Due to Tax Fund ............................................................... 5,000
Cash .................................................................................. 25,000
To record salary expense and taxes.

(4) Due to Tax Fund ...................................................................... 5,000

Cash .................................................................................. 5,000
To record remittance of taxes.

(5) Utilities Expense ...................................................................... 2,200

Due to Enterprise Fund .................................................... 2,200
To record power and light expense.

(6) Supplies Expense ..................................................................... 10,050

Supplies Inventory ............................................................ 10,050
To record supplies used.

(7) Due from Electric Enterprise Fund ......................................... 300

Due from Special Revenue Fund ............................................ 4,750
Billings for Services ......................................................... 5,050
To record billings.

(8) Supplies Inventory Shrinkage ................................................. 50

Supplies Inventory ............................................................ 50
To adjust accounts to physical inventory.
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Problem 11-3 (a) (continued)

(9) Cash .......................................................................................... 39,300

Due from Electric Enterprise Fund .................................. 300
Due from General Fund ................................................... 35,000
Due from Special Revenue Fund ..................................... 4,000
To record receipts.

(10) Repairs Expense ....................................................................... 75

Due to Maintenance Fund ................................................ 75
To record repairs not paid.

(11) Cash .......................................................................................... 1,500

Accounts Receivable ........................................................ 1,500
To record receipts on account.

(12) Accounts Payable ..................................................................... 14,950

Cash .................................................................................. 14,950
To record payments of accounts payable.

(13) Depreciation Expense—Equipment ......................................... 2,500

Accumulated Depreciation—Equipment ......................... 2,500
To record one year's depreciation.

Problem 11-3 (b)

Closing Entries

Billings for Services ............................................................................. 41,050

Excess of Costs Over Billings for Services ......................................... 3,825
Supplies Expense .......................................................................... 10,050
Utilities Expense . .......................................................................... 2,200
Repairs Expense ............................................................................ 75
Salary Expense .............................................................................. 30,000
Depreciation Expense—Equipment ............................................. 2,500
Supplies Inventory Shrinkage ...................................................... 50
To close accounts and calculate excess of costs over billings.

Net Position ........................................................................................... 3,825

Excess of Costs Over Billings for Services ................................. 3,825
To close excess of costs (expenses) over billings for services to Net Position.

Problem 11-3 (c)

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 City of Morristown
Central Printing (Internal Service) Fund
Postclosing Trial Balance
June 30, 20X9

Cash ...................................................................................................... $30,850

Due from General Fund ....................................................................... 3,000
Due from Special Revenue Fund ......................................................... 750
Supplies Inventory ................................................................................ 5,900
Equipment ............................................................................................. 25,000
Accumulated Depreciation-Equipment ............................................... $11,250
Accounts Payable ................................................................................. 2,800
Due to Maintenance Fund .................................................................... 75
Due to Enterprise Fund ........................................................................ 2,200
Advance from General Fund ................................................................ 20,000
Net Position .......................................................................................... ______ 29,175
$65,500 $65,500

Problem 11-3 (d)

Computation of Net Position at December 31, 20X9

Unrestricted Net Investment in

Asset/Liability Net Position Capital Assets
Cash $30,850
Due from Other Funds 3,750
Supplies Inventory 5,900
Capital Assets $13,750
Accounts Payable (2,800)
Payables to Other Funds (22,275)
Totals $15,425 $13,750

Problem 11-4
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(a)
City of Merlot
Central Garage Fund
Journal Entries
July 1, 20X9 to June 30, 20Y0

1. Inventory of Materials and Supplies ....................................... 74,000

Vouchers Payable .............................................................. 74,000
To record purchases on account.

2. Materials and Supplies Expense ............................................... 96,000

Inventory of Materials and Supplies ................................ 96,000
To record ending inventory and materials and
supplies used.

3. Personal Services Expense ....................................................... 230,000

Cash ................................................................................... 230,000
To record personal services expense paid.

4. Utility Expense.......................................................................... 30,000

Cash ................................................................................... 30,000
To record payment of utility charges.

5. Depreciation Expense—Building ............................................ 5,000

Depreciation Expense—Machinery and Equipment ............... 8,000
Accumulated Depreciation—Buildings............................ 5,000
Accumulated Depreciation—Machinery and
Equipment .................................................................. 8,000
To record depreciation.

6. Due from General Fund ........................................................... 262,000

Due from Water and Sewer Fund............................................. 84,000
Due from Special Revenue Fund ............................................. 32,000
Service Revenue ................................................................ 378,000
To record billings to departments for services rendered.

7. Cash ........................................................................................... 376,000

Due from General Fund ................................................... 276,000
Due from Water and Sewer Fund ..................................... 84,000
Due from Special Revenue Fund ...................................... 16,000
To record collection of receivables.

8. Vouchers Payable ..................................................................... 98,000

Cash ................................................................................. 98,000
To record payment of vouchers.

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Problem 11-4 (b)

City of Merlot
Central Garage Fund
Closing Entries
June 30, 20Y0

Service Revenue ....................................................................... 378,000

Materials and Supplies Expense ....................................... 96,000
Personal Service Expense ................................................. 230,000
Utility Expense .................................................................. 30,000
Depreciation Expense—Building ..................................... 5,000
Depreciation Expense—Machinery and
Equipment .................................................................. 8,000
Excess of Revenues over Expenses .................................. 9,000
To close revenue and expense accounts.

Excess of Revenues over Expenses.......................................... 9,000

Net Position ....................................................................... 9,000
To close Excess of Revenues over Expenses to Net Position.

Problem 11-5 (a) [Note – See Excel File for 11-5(a)]

Problem 11-5 (b)

Computation of Net Position at December 31, 20X6

Unrestricted Net Investment in

Asset/Liability Net Position Capital Assets
Cash $11,100
Due from Other Funds 41,600
Inventory 23,000
Capital Assets $95,000
Vouchers Payable (25,000)
Capital Lease Liability (6,800)
Totals $50,700 $88,200

Problem 11-6
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 METRO SCHOOL DISTRICT
Repair Shop (Internal Service) Fund
Statement of Cash Flows
For the Year Ended December 31, 20X6

Cash Flows from Operating Activities:

Cash received from user departments ..................................... $27,900
Cash paid for materials ............................................................ (30,000)
Cash paid to employees ........................................................... (12,000)
Cash paid for utilities ............................................................... (3,500)
Net cash used by operating activities ............................... (17,600)
Cash Flows from Capital and Related Financing Activities:
Cash paid for equipment .......................................................... (300)
Cash paid to retire debt ............................................................ (900)
Cash paid for interest ............................................................... (100)
Net cash used for capital and related financing
activities ....................................................................... (1,300)
Net decrease in cash ................................................................. (18,900)
Cash and cash equivalents, beginning of year ..................................... 30,000
Cash and cash equivalents, end of year ............................................... $11,100

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Solution Manual for Governmental and Nonprofit Accounting 10th Edition by Freeman

SOLUTIONS TO CASES

Case 11-1

1. Inventory .....................................................A
Charges for current services........................ H
Depreciation expense ................................... I
Accounts payable ........................................D
Unrestricted net position ............................. G
Accrued payroll ...........................................D
Capital assets, net of depreciation ............... B
Net investment in capital assets ..................G
Salaries and benefits .................................... I
Interest income ............................................. J
Cash and cash equivalents .......................... A
Transfers out ...............................................K

2. Internal Service Funds are required to be reported by fund type in the basic financial
statements. Therefore, all four Internal Service Funds for the County of San Luis Obispo
will be combined into one column on the proprietary funds’ statement of net position,
statement of revenues, expenses, and changes in net position, and statement of cash
flows. Combining financial statements, however, must be presented in the combining
and individual funds section of the Comprehensive Annual Financial Report (following
the basic financial statements) since the county has more than one Internal Service Fund.

Case 11-2

1. a. The city of Great Falls, Montana, will report a combined column that includes all
four Internal Service Funds in each of the required proprietary funds financial
statements in the basic financial statements. This is known as reporting by fund
type.
b. In the combining financial statements, the city will report an individual column for
each Internal Service Fund on each of the required financial statements.

2. The classifications for net position are the same for Internal Service Funds as they
are for Enterprise Funds. Specifically, the classifications are:
• Net investment in capital assets
• Restricted net position
• Unrestricted net position

3. There are three required financial statements for Internal Service Funds. They are:
• Statement of net position
• Statement of revenues, expenses, and changes in net position
• Statement of cash flows

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