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Chapter 9

Business-Type Activities

Chapter 9

Learning Objectives
Why governments and NFPs engage in businesstype activities
Distinguish between Proprietary and
Governmental activities
Fundamental principles of Proprietary Fund
Enterprise Funds
Internal Service Funds
Accounting for Insurance Activities
GASB 34, special problems of reporting
proprietary funds in government-wide statements
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Proprietary Funds
Reasons for use
-To compare benefits and costs of the
business-type activities of a government.
-Enhances management of activities
in which goods or services are
provided on a cost-reimbursement basis
to departments of the same government
or to the general public on a user charge basis.

Example: the city of Houston maintains two

different types of proprietary funds.
-Enterprise funds and Internal Service funds
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Proprietary Funds
Two types of funds are classified as proprietary:
Internal service funds:
-Provide services to other government departments on a
user charge basis.
-Example: City of Houston Health Benefit and Longterm Disability funds.

Enterprise funds:
-Provide services to the general public on a user charge
-Example: City of Houstons Airports (Bush, Hobby and
Ellington Field), George R. Brown Convention Center,
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Proprietary Funds
Accounting Characteristics
-Full accrual basis
-Recognize revenues as earned and expenses as incurred.
-Balance sheet recognition to both capital assts and long-term debt.
-Full accrual basis
-Capital assets and long-term liabilities accounted for within the
-Resources are donor-restricted and classified per FASB Statement
No. 117

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Business-Type Vs. Governmental Activities

Business-type accounting used to account for
proprietary funds:
Full accrual basis
Measurement focus on all economic resources is
consistent with GASB
Information on depreciation
Facilitates comparisons with private enterprises

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Proprietary Funds
Required Financial Statements
Similar to those for a for-profit entity:

Statement of Net Assets (or Balance Sheet):

-Invested in capital assets, net of related debt
-Restricted Net assets
-Unrestricted Net Assets

Statement of Revenues, Expenses, and changes in Fund Net Assets:

-comparable to income statement of a business
-Reconciles beginning and ending net assets

Statement of Cash Flows:

-Required for proprietary funds but not
governmental funds
-Summarizes the entitys cash account

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Statement of Cash Flows

FASB Statement No. 95 classifies cash transactions

Cash flows from operating activities

Cash flows from financing activities
Cash flows from investing activities
This is not applicable to governments.

GASB Statement No. 9:

Cash flows from operating activities

Cash flows from non capital financing activities
Cash flows from capital and related financing activities
Cash flows from investing activities

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Proprietary Funds
Accounting Equation
Assets = Liabilities + Net Assets


(e.g., for payment of
debt service)

Invested in Capital
Assets, Net of
Related Debt

Recall this is the same classification of net

assets that is required under GASB 34.
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Enterprise Funds
Enterprise funds are used to report the same functions
presented as business-type activities in the
government-wide financial statements.
Reasons for use
Used to
-Account for services provided to the general public on a user charge basis
or where the governing body has determined that periodic
determination of revenues earned, expenses incurred, and/or net
income is appropriate
-For capital maintenance, public policy, management control,
accountability, or other purposes

The City of Houston uses enterprise funds to account for its

aviation system, combined utility system (formerly called
the water and sewer system), and the convention and
entertainment facilities.
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Common Types of Enterprise Funds

Water and sewer (public utilities)
Gas and electric utilities
Transportation systems
Airports (Bush, Hobby, Ellington Field)
Ports (Port of Houston)
Toll roads and bridges (Sam Houston Tollway Beltway 8)
Parking garages and lots (Theater District parking garage)
Golf courses (Hermann Park)
Hospitals (Ben Taub)
Liquor stores.

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Accounting for Enterprise Funds

GASB Statement No. 34 provides guidance on business-type activities:
Use of enterprise funds when one of the following criteria is met:
Activity financed solely with revenue debt instead of governmental
obligation debt.
Costs of providing services recovered by fees and charges
Pricing policy establishes fees and charges to recover costs
Previously, GASB standards allowed proprietary funds two options:
Follow pronouncements of the FASB and its predecessors issued
before November 30, 1989, unless they conflict with a GASB
Follow all FASB and predecessor standards, both those issued
before and after November 30, 1989, unless they conflict with a
GASB standard
Note that GASB standards always take priority

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Enterprise Funds Restricted Assets

Definition: Assets whose use is restricted by contractual
agreements or legal requirements
Typical examples:
Customer deposits of utilities, assets set aside for repayment of
revenue bond principal, reserves for maintenance of plant, and
funding of depreciation

Ideally liabilities to be paid from restricted assets should

be reported separately from liabilities to be paid from
unrestricted assets.
Net Assets - Restricted assets should be reported in the
Equity section of the Statement of Net Assets.

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Enterprise Funds
Utility Plant - Construction in Progress
Q: Should interest incurred on debt during construction
be capitalized?
A: Yes.

Q: Should an imputed amount equivalent to

interest be capitalized if a utilitys own
funds are used for construction?
A: Capitalizing an equity component of
Allowance for Funds Used During
Construction (AFUDC) is permitted both
by utility regulators and the FASB.
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Enterprise Funds
Special Current Liabilities
In addition to the usual Accounts Payable and
Accrued Expenses, use two special current liability
Customers Advances for Construction
Usually up-front deposits required to be made by
builders to provide all or part of the cost of
connecting new structures to utility lines. May or
may not be refunded in part upon completion

Customer Deposits
Usually reported under the caption Liabilities
Payable from Restricted Assets
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Enterprise Funds
Regulatory Accounting Principles (RAP)
Key RAP definitions
Original cost: The (depreciated) cost to the
first owner to place the utility plant into
public use
Utility Plant Acquisition Adjustment: The
difference between the purchase price of a
utility plant less the net original cost of the
plant on the sellers books.
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Municipal Solid Waste Landfills

Accounted for either in governmental or
enterprise funds
If usage fees are chargedaccounted for in
enterprise funds.
Governments have to report both -- expense and
Liability of post closure costs reported only in
Pay-as-you-go basis

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Municipal Solid Waste Landfills (contd)

An EPA rule requires all municipal landfills to meet stringent

location, design, and operating requirements to minimize the potential
for environmental damage.

Operators must also provide financial assurance they can properly

close landfills when full and provide post-closure ground water
monitoring for 30 years after closure.

These stringent rules are designed to protect the environment from

irresponsible handling of hazardous materials
Estimate the current cost of hiring a qualified third-party to close
the MSWLF and care for it for 30 years after closure
Recognize a portion of this cost proportionate to the ratio of
estimated capacity utilized during a year over the total capacity of
the landfill as an expense of the enterprise fund and as a liability
Annual adjustments are made as estimates change from year to

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Enterprise Funds Segment Information

When there are multiple enterprise

Summary operating data, including
extent of intra- governmental subsidies,
should be disclosed in the notes for
"major non-homogeneous enterprise

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Internal Service Funds

Used to account for services provided by governmental units to other
governments on a cost reimbursement basis.
These funds are accounting entities.
Promotes efficiency
Usually accounted for in general fund or some governmental fund
Authorized by legislative approval
ISF resources are rarely restricted.
Accounted for in general fund or other governmental fund.
Reasons for use: Improve

management of common resources by

placing them under centralized management and control

The City of Houston uses internal service funds to account for health and
benefits and long-term disability activities.
Because both of these services predominantly benefit governmental rather than
business-type functions, they have been included within governmental activities
in the government-wide financial statements.

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Accounting for Internal Service Funds

Revenues recognized when earned.

Expenses recognized on full accrual basis.

Derives revenues mainly from other governmental or proprietary


Accounting for both ISF & enterprise funds: must follow all FASB
pronouncements issued prior to Nov. 30th 1989 unless it conflicts with
GASB pronouncement.

Generally should use the same accounting procedures that a similar

for-profit entity would use. Billings to Departments is the revenue
account that is similar to Sales of a for-profit entity

Revenues and expenses are closed at year-end to Excess of Net

Billings to Departments over Costs (or Excess of Costs over Net
Billings to Departments) rather than to Income Summary

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Common Types of Internal Service Funds

Motor pools
Central purchasing
Issuance of supplies
Self-insurance pools
Central data processing

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Internal Service Funds Financial Statements

Other than the slight difference in
terminology, the financial statements are
essentially the same as those of a comparable
for-profit entity.
Statement of Net Assets
Statement of Revenues, Expenses, and Changes in
Net Assets
Statement of Cash Flows - prepared in conformity
with GASB standards rather than FASB standards.

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Internal Service Funds Statement of Cash

Similarities between GASB and FASB
Cash Flows Statement shows cash
inflows/outflows relating to operating,
financing, and investing activities
Both sets of standards define cash
flows as cash and cash equivalents
(i.e., time deposits, marketable
securities, and other items readily
convertible to cash)

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Internal Service FundIllustration

Q: Assume that one of the governments internal service funds was for
data processing services, for which the golf course was billed $30,000,
all of which was classified as contractual services in the golf course
fund. How would that amount be reported in the column for ISF?
How would it be reported in the government-wide financial
A: Fund Statements: Billings of ISF would be reported as a revenue of
ISF and as an expense of the golf course. The related cost of
providing the service would be reported as an expense of the ISF.
Government-wide: Billings would be reported ONLY as an expense
of the golf course. The revenues and expenses of the ISF would be
eliminated in the consolidation process.

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Internal Service Funds

Capital Assets and Depreciation
Depreciation of capital assets
acquired by contributions or grants.

The issue is: should the ISF be able

to recover in its prices or rates a cost
it did not incur for such assets?

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ISF Illustration
Q: ISF reported $2.7 million in depreciation, an
amount that the government takes into account in
establishing the rates charged to other funds. How
would this charge be reflected in the governmentwide statements?
A: The depreciation charges are incorporated into the
amounts billed to the funds to which the ISF
provide services. Therefore, in the governmentwide, they would be incorporated into the expenses
of the functions accounted for in those funds.
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ISF Example
Q: In which column on the government-wide
statement of net assetsthat for governmental
or business-type activitiesis it most likely that
the assets and liabilities of the ISF would be
A: Unless the ISF provide services mainly to units
accounted for in proprietary funds, their assets
and liabilities would be reported in the column
for governmental-type activities.
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Pricing Policies for Internal Service Funds

Pricing is set by local management or by
legislative policy
Pricing objectives vary
Can cover full costs (direct and indirect),
direct costs only, or whatever management
Full cost prices do not reflect cost of providing
incremental amounts of goods or services.
Legislative bodies are sometimes reluctant to
establish ISFs because they are do not wish to
let purchasing occur outside the budget.

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Internal Service Funds (contd)

Q: Is this a real concern?
Even if an ISF is created for central
purchasing and sales of supplies, the
legislative body still maintains budgetary
control over the expenditures made by
most departments and programs via the
General Fund and special revenues funds

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Internal Service Funds

GASB-mandated use of an ISF
GASB standards require that an ISF be used for risk
management (self-insurance) pools of a government:
The ISF should recognize claims expense and a related liability
it is probable that an asset has been impaired or a liability has
been incurred and the amount is reasonably estimable, or
if an estimable loss has been incurred and it is probable that a
claim will be asserted
Disclose other loss contingencies in the notes.

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ISF Accounting Procedures

Critical Implications:
Duplicate reported expenses:
costs and revenues are reported twice within the same set of
financial statements.

Transfer of depreciation to governmental funds

Detract from Objectivity of Financial Statements
Obscure Fund Balance Surpluses or Deficits:
surpluses/deficits can be transferred from general fund to the
internal service fund.

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Terminating an Internal Service

Transfer ISF's assets to another fund which will
continue same activity
Terminate activity and distribute assets in-kind to
another fund or funds
Convert ISF's assets to cash and distribute cash
to another fund or funds

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Governments elect to self-insure their risks

Reduces portion of the premium
Accounted for in either general fund or ISF.
Insurance department acts as an independent insurance
Self insurance is no insurance: no transfer of risks to
It simply sets aside funds to provide for possible losses.
Payments for self-insurance premiums:
Only portion of the premium is reported as expenditurethis
amount is recognized as revenue in ISF.
Excess is treated as a nonreciprocal transfer.

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Business Type Activities

Proprietary funds (internal service and enterprise) are used
to account for the business-type activities of a government
Accrual accounting is used for proprietary funds and the
required financial statements are the same as those for a
for-profit entity, except that GASB standards must be used
where they apply
ISF are reported as governmental activities on the
government-wide statements
Regulatory accounting terminology and principles are
used by some government owned utilities.

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