Government & NFP Accounting Chapter Two

CHAPTER TWO
Principles of Accounting and Financial Reporting for State and local Government
Entities
ACTIVITIES OF GOVERNMENT
Chapter 1 explained that the characteristics of governmental organizations differ from those of
for-profit business organizations. One key difference is that governments are not profit seeking
but exist to meet citizens’ demand for services, consistent with the availability of resources to
provide those services. Governments must also incur costs for general administrative support such
as data processing, finance, and personnel. Governments also engage in a variety of business-
type activities. These activities include, among others, public utilities (e.g., electric, water, gas,
and sewer utilities), transportation systems, toll roads, toll bridges, hospitals. Many of these
activities are intended to be self-supporting by charging users for the services they receive.
A final category of activity in which governments are involved is fiduciary activities.
Governments often act in a fiduciary capacity, either as an agent or trustee, for parties outside the
government. For example, a government may serve as agent for other governments in
administering and collecting taxes. Governments may also serve as trustee for investments of
other governments in the government’s investment pool, for escheat properties that revert to the
government when there are no legal claimants or heirs to a deceased individual’s estate, and for
assets being held for employee pension plans, among other trustee roles.
2.1 GAAP Vs legal Compliance (Accounting and Reporting Capabilities)
A governmental accounting system must make it possible both: (a) to present fairly and with
full disclosure the funds and activities of the government in conformity with generally
accepted accounting principles, and (b) to determine and demonstrate compliance with
finance-related legal and contractual provisions.
2.2 FUND AND FUND ACCOUNTING
Governmental accounting systems should be organized and operated on a fund basis.
A fund is defined as a fiscal and accounting entity with a self-balancing set of accounts
recording cash and other financial resources, together with all related liabilities and residual
equities or balances, and changes therein, which are segregated for the purpose of carrying

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on specific activities or attaining certain objectives in accordance with special regulations,
restrictions, or limitations.
To distinguish fund (NFP) Accounting from FP Accounting it will be noted that an FP is
accounted for as one entity. However, a single NFP unit may be treated as several different
entities. Each of these entities is a fund.
Example
Ministry of education operates several universities. Although all are part of the ministry of
education as a whole, each one is treated as a fund. Each university will be given money that is
specifically for its operation, and is not mixed up with other institutions. Therefore, each
university will keep its own sets of books, and issue its own financial reports, irrespective of the
performance of other individual institutions or the ministry as a whole.
Two kinds of Funds
Expendable funds: - are meant to be expended (entirely used up), usually within one year. As a
practical matter any money that remains in an expendable fund at the end of the year typically
must be returned to its source.
Non-Expendable Funds: - Are used when maintenance of capital is desired, and the
Unexpended funds are not meant to be returned. The accounting for a non- expendable funds very
closely resembles that of profit making entity. Non- expendable funds are sometimes called
proprietary funds.
2.3. Types of funds
There are seven types of funds which are divided in to three categories
The following types of funds should be used by state and local governments
1. Governmental funds
I. The General Fund—to account for all current financial resources except those required
to be accounted for in another fund.
II. Special Revenue Funds—to account for the proceeds of specific revenue sources (other
than private-purpose trusts or for major capital projects) that are legally restricted to use
for specified purposes.

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Example: - The unity and safety of motherland tax that was collected during the Derge regime.
This tax was collected specifically armed forces.
III. Capital Projects Funds—to account for financial resources to be used for the acquisition or
construction of major capital facilities (other than those financed by proprietary funds and trust
funds).
IV. Debt Service Funds—to account for the accumulation of resources and the payment of
general long-term debt principal and interest.
2. Proprietary Funds
V. Enterprise Funds—may be used to report any activity for which a fee is charged to
external users for goods or services. An enterprise fund must be used if (a) if they are
financed and operated in a manner similar to business enterprises (b) laws and regulations
require that the costs of providing services, including capital costs such as depreciation or
debt service, be recovered from fees and charges, or (c) pricing policies of the activity are
intended to recover its costs, including capital costs.
VI. Internal Service Funds—to account for the financing of goods or services provided by
one department or agency to other funds, departments, or agencies of the governmental
unit, or to other governmental units, on a cost-reimbursement basis.
3. Fiduciary Funds (and similar component units). These are trust and agency funds that
are used to account for assets held by a governmental unit in a trustee capacity or as an
agent for individuals, private organizations, and other governmental units.
VII. Agency funds IX. Investment trust funds.
VIII. Pension/trust (and other employee
benefit)

2.4. Number of Funds

Governmental units should establish and maintain those funds required by law and Sound
financial administration. Only the minimum number of funds consistent with legal and
operating requirements should be established, however, because unnecessary funds result in
inflexibility, undue complexity, and inefficient financial administration.

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2.5. Basis of Accounting
The modified Accrual basis or Accrual basis of Accounting, as appropriate should be used in
measuring financial position or operating results.
A) Governmental funds revenues and expenditures should be recognized on the modified
accrual basis of Accounting. Revenues should be recognized in the Accounting period in
which they become available and measurable. Expenditures should be recognized in the
accounting period in which the fund liability is incurred, if measurable except for un-matured
interest on general long-term debt.
 Measurable means when the amount to be collected is known with some certainty.
 Available means the taxes are available to cover spending in the year of recording (usually
interpreted to mean during the fiscal year, or within 60 days of the end of the fiscal year.
B) Proprietary funds Revenues and expenses should be recognized on Accrual basis.
C) Fiduciary funds revenues and expenses or expenditures (as Appropriate) should be

recognized on the basis consistent with the funds accounting measurement objective.
Non-expendable Trust funds should be accounted for on the Accrual basis. Expendable trust
funds should be accounted for on the modified Accrual basis.
Agency funds’ assets and liabilities should be accounted for on the modified Accrual basis.
Inter fund transfers should be recognized in the Accounting period in which the inter fund
receivable and payable arise.
2.6. Fixed Assets and Long-term liabilities
A clear distinction should be made between A) Fund fixed assets and general fixed assets and
B) Fund long -term liabilities general long-term debt.
A. Fixed Assets related to specific proprietary funds or trust funds should be accounted for
through those funds. All other fixed assets of a governmental unit should be accounted for
through the general fixed assets account group.
Example:- purchase of Equipment for cash is recorded as follows
In proprietary funds in General funds
Equipment -------------XXX Expenditure ----------XXX
Cash --------------------------XXX cash ------------------XXX
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B. Long-term liabilities of proprietary funds or trust funds should be accounted for
through those funds. All other unmatured general long-term liabilities of the governmental unit
should be accounted for through the general long-term Debt account group.
2.7. Valuation of Fixed Assets
Fixed Assets should be accounted for at cost or, if the cost is not practically determinable at
estimated cost. Donated fixed assets should be recorded at their estimated fair value at the time
received.
2.8. Depreciation of fixed assets
A. Depreciation of fixed assets of general fixed assets should not be recorded in the accounts of
governmental funds. Depreciation of general fixed assets may be recorded in cost analysis,
and accumulated depreciation may be recorded in the general fixed assets account group.
B. Depreciation of fixed assets accounted for in a proprietary fund should be recorded in the
accounts of that fund. Depreciation is also recognized in those trust funds where expenses, net
income and/or capital maintenance are measured.
2.9. Budgeting and Budgetary Control
A) An annual budget(s) should be adopted by every governmental unit.
B) The accounting system should provide the basis for appropriate budgetary control.
C) Budgetary comparisons should be included in the appropriate financial statements and
schedules for governmental funds for which an annual budget has been adopted.
2.10. Financial Reporting
A) Interim Financial statements
Appropriate interim financial statements and reports of financial position, operating results, and
other pertinent information should be prepared to facilitate mgt control of financial operations,
legislative oversight, and where necessary or desired for external reporting purposes.
B) Comprehensive Annual Reports
Comprehensive annual financial reports covering all funds and account groups of the
government unit including appropriate combined, combining, and individual fund statements,
notes to the financial statements, schedules narrative explanatory and statistical tables should be
prepared and published.

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C) General purpose financial statements: - may be issued separately from the
comprehensive financial reports. Such statements should include the basic financial
statements and notes to the financial statements that are essential to fair presentation of
financial position and operating results (and changes in financial of position proprietary funds
and similar trust funds)
2.11. Classification of transfers and long-term Debt proceeds
A) Inter-fund transfer and proceeds of general long-term debt issues should be classified
separately from revenues and expenditures.
Inter fund transfers: - a transfer from one fund within the unit to another fund within the
unit. For example An NGO operates clinics and these clinics charge to cover wages and
medicines. During the year one clinic had a surplus and another had a shortage. The head of
the organization decides to transfer funds from the one with a surplus to the one with a
shortage.
Proceeds of general- long term debt issues: - money that is received from borrowing by
the entity as a whole, backed by the full faith and credit of governmental unit.
N.B These two sources of resources should appear distinct from revenues and expenditures on
the entity’s financial statements.
Classification of Revenues and expenditures
 Governmental fund revenues should be classified by fund and source
Example the fund might be General fund and the source might be tax collection.
 Expenditures should be classified by fund, function (program), organization unit,
activity, character, and principal classes of objects.
Example The fund -------------------- General fund
Function----------------- service
Organization unit---------- police
Activity --------------- foot patrols
Character----------------- current expenditure
Object------------------- office supplies
B) Proprietary fund revenues and expenditures
Proprietary fund revenues and expenditures should be classified in essentially the same manner as
those of similar business organizations, functions or activities. Expenses rather than expenditures are
recorded in proprietary funds.
2.12. Common Terminology
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A common terminology should be used essentially throughout the budget, the accounts, and the
financial reports of each fund.

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