Chapter

4
Accounting for Governmental
Operating Activities—Illustrative
Transactions
and Financial Statements

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning Objectives

After studying Chapter 4, you should be able to:

h Analyze typical operating transactions for
governmental activities and prepare appropriate
journal entries at both the government-wide and fund
levels
h Prepare adjusting entries at year-end and a pre-
closing trial balance
h Prepare closing journal entries and year-end General
Fund financial statements

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 Learning Objectives (Cont’d)

h Account for interfund and intra- and inter-activity

transactions
h Account for transactions of a permanent fund
h Distinguish between exchange and nonexchange
transactions, and define the classifications used for
nonexchange transactions

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 Governmental Funds

v Measurement focus: Governmental funds focus

on the flow of current financial resources
l Assets include cash, receivables, marketable securities,
prepaid items, and supplies inventories
l Liabilities include current liabilities such as accounts or
vouchers payable, accrued liabilities, and deferred
revenues
l Capital assets and noncurrent liabilities are not recorded
in governmental funds, but are recorded in governmental
activities at the government-wide level
v Basis of accounting: Modified accrual

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 The Dual-Track Approach

v Dual-track approach
l Transactions have different effects on
governmental funds and governmental activities
at the government-wide level because of
different measurement focuses and bases of
accounting
l Using the dual-track approach each transaction
is recorded separately in the general journals
for the governmental fund and governmental
activities

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 Recording the Budget
at the Beginning of the Year

The budget for Clark City authorizes expenditures of

$11,360,000 and forecasts revenues of
$10,972,000 for FY 2014. The entry to record the
budget (ignoring subsidiary detail) is:

General Fund: Dr. Cr.

Estimated Revenues 10,972,000
Budgetary Fund Balance 388,000
Appropriations 11,360,000

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 Recording the Budget
at the Beginning of the Year (Cont’d)

Question: Referring to the budget just

recorded in which appropriations exceed
estimated revenues by $388,000, is this an
example of poor financial management? (See
next slide)

4-7
 Q: Is This an Example of Poor
Financial Management?

Answer: A budgetary deficit does not necessarily

indicate poor financial management
v To provide a financial cushion to cover revenue
shortfalls or unexpected expenditure needs,
governments usually maintain a “target” ratio of
spendable Fund Balances to General Fund
Revenues in the range of 10 to 25 percent
v If the cushion is larger than the target level, the city
council (or other legislative body) may intentionally
budget a deficit to reduce fund balances

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 Encumbrance Accounting

Before a department can order materials and

supplies or equipment, the department should
verify that a sufficient unexpended appropriation
exists to cover the items being ordered

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 Encumbrance Accounting (Cont’d)

Assume that the following departments of Clark

City place purchase orders for supplies totaling
$420,000, the entry would be:
General Fund: Dr. Cr.
Encumbrances—2014 420,000
Encumbrances Outstanding—2014 420,000
Encumbrances Subsidiary Ledger:
General Government 80,000
Public Safety 210,000
Public Works 130,000

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 Accounting for Expenditures

Clark City recorded expenditures of $432,000 for

goods received that had been ordered in the
preceding transaction
General Fund: Dr. Cr.
Encumbrances Outstanding—2014 420,000
Expenditures—2014 432,000
Encumbrances—2014 420,000
Vouchers Payable 432,000

See next slide for subsidiary ledger entries

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Accounting for Expenditures (Cont’d)

Expenditures Ledger: Dr. Cr.

General Government 78,000
Public Safety 220,000
Public Works 134,000

Encumbrances Ledger:
General Government 80,000
Public Safety 210,000
Public Works 130,000

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Accounting for Governmental Activity
Expenses

Governmental Activities: Dr. Cr.

Expenses—General Government 78,000
Expenses—Public Safety 220,000
Expense—Public Works 134,000
Vouchers Payable 432,000

Note that the earlier budgetary entry for

encumbrances has no effect at the government-
wide level

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 Accounting for Payroll

Payroll accounting is similar for a governmental fund

and a for-profit entity, except expenditures rather than
expenses are recorded
v Debit Expenditures for the full amount of payroll and
credit liabilities for withholdings from employees’ pay;
credit Cash for the amount paid to employees
v Record Expenditures for the employer’s payroll costs,
including employer’s share of FICA and credit a liability
to the federal government.
v Encumbrances usually are not recorded for recurring
expenditures such as payroll

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Illustrative Journal Entries for Payroll

Clark City recognized its payroll for the most

recent two week pay period for employees paid
from the General Fund
General Fund: Dr. Cr.
Expenditures—2014 948,000
Due to Federal Government 86,000
Due to State Government 49,000
Cash 813,000
Expenditures Subsidiary Ledger:
General Government 178,000
Public Safety 480,000
Public Works 290,000
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Illustrative Journal Entries for Payroll
(Cont’d)
The journal entry to record the payroll in the
governmental activities journal at the
government-wide level is:
Governmental Activities: Dr. Cr.
Expenses—General Government 178,000
Expenses—Public Safety 480,000
Expenses—Public Works 290,000
Due to Federal Government 86,000
Due to State Government 49,000
Cash 813,000

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Illustrative Journal Entries for Payroll
(Cont’d)

The employer’s share of FICA is recorded in

the General Fund
General Fund: Dr. Cr.
Expenditures—2014 88,000
Due to Federal Government 88,000
Expenditures Ledger:
General Government 16,523
Public Safety 44,557
Public Works 26,920

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 Illustrative Journal Entries for Payroll
(Cont’d)

The employer’s share of FICA is recorded in the

governmental activities journal
Governmental Activities: Dr. Cr.
Expenses—General Government 16,523
Expenses—Public Safety 44,557
Expenses—Public Works 26,920
Due to Federal Government 88,000

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Accounting for Property Tax Revenue

v The tax levy is the amount billed to taxpayers

v Initial determination of required tax levy: Levy =
Revenues required ÷ Estimated collectible
proportion

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 Accounting for Property Tax
Revenue (Cont’d)

v The tax rate is the measure that is actually set by

legislative action, after the required size of the
levy is determined. Tax rate (per $100 or per
$1,000 of assessed valuation) = required tax levy
÷ assessed valuation (see next slide for definition
of assessed valuation)

v If tax rate exceeds the statutory limit it will be

necessary to reduce the required tax levy and
readjust the budget accordingly

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 Accounting for Property Tax
Revenue (Cont’d)

v Assessed valuation is generally determined by

an elected “Tax Assessor”
v Calculation: Assessed valuation =
estimated true value of taxable
property X assessment ratio

v In many jurisdictions the assessment ratio is

1.00 (i.e., full estimated market value); in other
jurisdictions it might be some fraction of full
value
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 Illustrative Journal Entries
for Property Taxes

Assume revenues of $495,000 are required and it is

estimated that 1% will be uncollectible:
Levy = $495,000/.99 = $500,000
(ignore subsidiary ledger entry)

General Fund: Dr. Cr.

Taxes Receivable—Current 500,000
Est. Uncollectible Current Taxes 5,000
Revenues 495,000

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 Illustrative Journal Entries
for Property Taxes (Cont’d)

The required entry at the government-wide level is

similar except for that the credit is to General
Revenues as follows:

Governmental Activities: Dr. Cr.

Taxes Receivable—Current 500,000
Est. Uncollectible Current Taxes 5,000
General Revenues—
Property Taxes 495,000

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 Illustrative Journal Entries
for Property Taxes (Cont’d)

Assume by the end of year $450,000 of current taxes

have been collected, the entry is:

General Fund and Governmental Activities: Dr. Cr.

Cash 450,000
Taxes Receivable—Current 450,000

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 Illustrative Journal Entries
for Property Taxes (Cont’d)

The entry to reclassify uncollected current taxes to

delinquent status at year-end:

General Fund and Governmental Activities: Dr. Cr.

Taxes Receivable—Delinquent 50,000
Estimated Uncollectible Current Taxes 5,000
Taxes Receivable—Current 50,000
Estimated Uncollectible Delinquent Taxes 5,000

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 Illustrative Journal Entries
for Property Taxes (Cont’d)

Interest and penalties of $500 are accrued on

delinquent taxes, of which 10% is estimated to be
uncollectible. (Ignoring subsidiary ledger entry)

General Fund: Dr. Cr.

Interest and Penalties Receivable on Taxes 500
Estimated Uncollectible Interest and Penalties 50
Revenues 450

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 Illustrative Journal Entries
for Property Taxes (Cont’d)

The required entry to accrue interest and penalties at

the government-wide level is similar, except for the
revenues account:

Governmental Activities: Dr. Cr.

Interest and Penalties Receivable on Taxes 500
Estimated Uncollectible Interest and Penalties 50
General Revenues—Interest and Penalties
on Delinquent Taxes 450

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 Illustrative Journal Entries
for Property Taxes (Cont’d)

Write-off of uncollectible taxes. Assume

property taxes of $500 are written off, on
which accumulated interest and penalties
amount to $80. The required journal
entry is:
General Fund and Governmental Activities: Dr. Cr.
Estimated Uncollectible Delinquent Taxes 500
Estimated Uncollectible Interest & Penalties 80
Taxes Receivable—Delinquent 500
Interest and Penalties Receivable on Taxes 80

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Issuance of Tax Anticipation Notes (TANs)

v Revenues from property taxes are often

collected during one or two months of the year

v Expenditure demands may occur more or less

uniformly during the year

v A local bank may extend a line of credit in the

form of TANs to meet short-term cash needs
since the notes will be backed by the power of
lien over taxable properties

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Tax Anticipation Notes - TANs (Cont’d)

Assume on April 1, 2014, Clark City signs a 60-day

$300,000 tax anticipation note, discounted at 6
percent per annum.
General Fund: Dr. Cr.
Cash 297,000
Expenditures—2014 3,000
Tax Anticipation Notes Payable 300,000

Note: 0.06 X 60/360 X $300,000 = $3,000. The entry at the

government-wide level would be the same, except the debit is
to Expenses—General Government instead of Expenditures

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 Tax Anticipation Notes - TANs (Cont’d)

Clark City repaid the 60-day $300,000 tax anticipation

note on the due date.

General Fund and Governmental Activities: Dr. Cr.

Tax Anticipation Notes Payable 300,000
Cash 300,000

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Revision of the Budget During the Year

Question: Why might a government need to

revise its legally adopted budget during the
year?

Discuss.

4-32
Q. Why Might a Government Need to Revise its
Legally Adopted Budget During the Year?

Answer: An error may have been made in

estimating revenues or expenditures, or
ongoing events and circumstances may have
altered estimated revenues or caused
unforeseen expenditure needs. Also, because
the budget is legally binding on managers, it is
important that the budget be revised to reflect
changed conditions

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Q: How are Budget Revisions Recorded?

Answer: If estimated revenues is increased,

debit Estimated Revenues and credit Budgetary
Fund Balance. If appropriations are increased,
debit Budgetary Fund Balance and credit
Appropriations
v A decrease in either item would result in the
reverse of the above entry
v Subsidiary ledger detail accounts would be
adjusted accordingly

4-34
 Encumbrances of a Prior Year

Accounting for encumbrances depends on the budget

laws of a particular state or other government
v Insome jurisdictions, appropriations do not expire at
year-end
v Inother jurisdictions, appropriations lapse and
encumbrances for goods on order at year-end require a
new appropriation in the next fiscal year
v Ifthe government is required or intends to honor
outstanding encumbrances at year-end, then there is no
need to close the Encumbrances account. If a new
appropriation is required, close Encumbrances and
reestablish it at the beginning of next year
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 Encumbrances of a Prior Year (Cont’d)

Assume at the end of FY 2013, the balance of the

Encumbrances account was $8,300 and the
government’s policy is to honor outstanding
encumbrances. Early in FY 2014, the goods are received
at an actual cost of $8,500.

General Fund: Dr. Cr.

Encumbrances Outstanding—2013 8,300
Expenditures—2013 8,300
Expenditures—2014 200
Encumbrances—2013 8,300
Cash 8,500
Note that only $200 is charged to the FY 2014 appropriation

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Encumbrances of a Prior Year (Cont’d)

In the preceding example, what if the actual cost of

the goods received had been only $8,100? How
would this affect the journal entries?

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 Encumbrances of a Prior Year (Cont’d)

Assume now that the actual cost of the goods

received in early FY 2014 is only $8,100 rather than
$8,500.
General Fund: Dr. Cr.
Encumbrances Outstanding—2013 8,300
Expenditures—2013 8,100
Encumbrances—2013 8,300
Cash 8,100

Note that the FY 2014 appropriation is unaffected since the

carryover 2013 encumbrance was more than adequate to
cover the expenditure.
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 Accounting for Inventories

v Two methods of inventory accounting: purchases

method and consumption method
v The purchases method is consistent with the modified
accrual basis of accounting since it reports total
expenditures for supplies purchased during the year.
The purchases method has traditionally been used by
governmental funds
v The consumption method is consistent with the accrual
basis of accounting since it reports the amount of
supplies consumed. It must be used at the
government-wide level and by proprietary funds

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 Accounting for Inventories (Cont’d)

v Specific journal entries during the year and

adjusting entries at year-end depend on whether
periodic or perpetual inventory procedures are
used
v On the following slides we illustrate the use of
periodic inventory procedures and the purchases
method for the General Fund and perpetual
inventory procedures and consumption method for
governmental activities at the government-wide
level

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Illustrative Journal Entries for Inventories

Purchases method, with periodic inventory procedures (General

Fund):
Using periodic inventory procedures, as is usual with the purchases
method, purchases of inventory during the year are recorded as:
General Fund: Dr. Cr.
Expenditures 100,000
Cash 100,000
The adjusting entry at year-end accounts for the assumed increase in
inventory:
Inventory of Supplies 5,000
Fund Balance—Nonspendable—
Inventory of Supplies 5,000

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Illustrative Journal Entries for Inventories

Consumption method with perpetual inventory procedures

(government-wide level):
Although periodic inventory procedures are often used, perpetual
inventory procedures are preferred when using the consumption
method. Purchases of inventory during the year are recorded
as:
Governmental Activities: Dr. Cr.
Inventory of Supplies 100,000
Cash 100,000
$95,000 of Inventory was issued for use during year. The
following entry summarizes total inventory issued.
Expenses (function detail omitted) 95,000
Inventory of Supplies 95,000
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 Future Accounting for Inventories?

v The authors anticipate that many governments

will shift to the consumption method for
governmental fund accounting since only the
consumption method is acceptable for use at the
government-wide level

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 Closing Journal Entries
Recommended by the Authors
v Reverse the original and revised budgetary entries
(Estimated Revenues, Estimated Other Financing
Sources, Appropriations, Estimated Other Financing
Uses, and Budgetary Fund Balance) (See Entry 23a in
the text)
v Close operating statement accounts (Revenues, Other
Financing Sources, Expenditures, and Other Financing
Uses) in a second entry, debiting or crediting fund
balance accounts as necessary to balance the entry
(See Entry 23b)
v Close Encumbrances to Encumbrances Outstanding,
but only necessary if a new appropriation is required

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 Special Revenue Fund Accounting

Purpose: Created when revenues are received that

must be expended for a specific operating
purpose
Examples:
v Motor fuel taxes earmarked for streets, roads, and
bridges
v Federal grant to operate a counseling program for
troubled youths
Accounting, budgeting, and financial reporting are essentially
the same as for the General Fund
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 Accounting for Operating Grants

Assume a grant of $100,000 is received in cash at

the beginning of the fiscal year from the federal
government to operate a counseling program for
troubled youths. Until the grant has been “earned”
by meeting eligibility requirements related to service
recipients, it is reported as “Deferred Revenue”—a
liability. The entry in the special revenue fund is:
Special Revenue Fund: Dr. Cr.
Cash 100,000
Deferred Revenue 100,000

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Accounting for Operating Grants (Cont’d)

Assume that during the year the Counseling Program

expended $75,000 for costs related to youth
counseling, while meeting eligibility requirements, the
entries would be:
Special Revenue Fund: 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 Revenues subsidiary ledger

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 SRF - Required Financial Statements

v Report special revenue fund activity in the

Governmental Activities column of the
government-wide financial statements
v Provide a column in the governmental funds
balance sheet and statement of revenues,
expenditures, and changes in fund balances for
the special revenue fund financial information if
the fund meets the definition of a major fund (see
Ch. 2 and the Glossary); otherwise report the
fund’s financial information in the “Other
Governmental Funds” column

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 Internal Exchange Transactions

v Transactions between two funds that are similar to

those involving the government and an external
entity
Example: Billing from a city’s water utility
fund (an enterprise fund) to the city’s
General Fund for the Fire Department
v The two funds recognize a revenue and
expenditure, respectively, rather than interfund
transfers in and out

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 Interfund Activity

Interfund loans
v Loans made from one fund to another with the intent
that they be repaid
v Classified as “Interfund Loans Receivable—Current (or
Payable—Current),” if the intent is to repay during the
current year; otherwise “Noncurrent”
Interfund transfers
v Nonreciprocal activity in which financial resources are
transferred between funds with no intention of
repayment
v The receiving fund records Other Financing Sources—
Interfund Transfers In; the giving fund records Other
Financing Uses—Interfund Transfers Out
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 Intra- versus Inter-Activity Transactions

Intra-activity transaction
v A transaction between two governmental funds (including an
internal service fund) or between two enterprise funds
v Neither governmental activities nor business-type activities is
affected at the government-wide level
Inter-activity transaction
v Interfund loans or transfers between a governmental fund
(including internal service fund) and an enterprise fund
v Report these as “Internal Balances” on the government-wide
statement of net position and “Transfers” on the statement of
activities

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 Permanent Funds

v To account for contributions received under trust

agreements in which the principal amount is not
expendable, but earnings can be expended for a
specified purpose
v Specifically intended for a public purpose (i.e., to
benefit a government program or function, or the
citizenry, rather than individuals, private
organizations, or other governments)

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 Exchange Transactions

v Transactions in which each party receives value

essentially equal to the value given
e.g., one party sells goods or services and the
other buys
v Recognize the revenue when it is earned, and
the expense/expenditure when it is incurred
v Exchange-like transactions are those in which
the values exchanged may be related but not
quite equal

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 Nonexchange Transactions

v External events in which a government gives/

receives value without directly receiving/giving
equal value in exchange
v Revenue recognition depends on time requirements—
the period in which the resources are required to be
(or may be) used
v In some cases, revenue recognition may be delayed
until program eligibility requirements are met
v Purpose restrictions are reported as restricted net
position or restricted fund balance, but do not delay
revenue recognition

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 Classes of Nonexchange Transactions

v Derived tax revenues

e.g., income and sales taxes
v Imposed nonexchange revenues
e.g., property taxes and fines and penalties
v Government-mandated nonexchange transactions
e.g., certain services funded by a higher level of
government
v Voluntary nonexchange transactions
e.g., grants and entitlements from higher levels of
government and certain private donations

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 Revenue Recognition Criteria for
Nonexchange Transactions

v Derived tax revenues

Recognize in the period in which the underlying
exchange occurs (sale occurs or income is earned)
v Imposed nonexchange revenues
Recognize when there is an enforceable legal claim or
in the period for which levied in the case of property
taxes
v Government-mandated nonexchange transactions
Recognize when all eligibility requirements have been
met. If cash is received before eligibility requirements
have been met, Deferred Revenues is credited
v Voluntary nonexchange transactions
Same as government-mandated nonexchange
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 Interim Financial Reporting

v Interim financial reporting is used for internal

management purposes; some governments
provide interim financial information on their Web
sites for the benefit of citizens and other interested
users
v At a minimum, interim budgetary comparison
schedules such as those shown in Illustrations B4-
1 and B4-2 of Appendix B should be prepared

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 Concluding Comments

v Mastery of the revenue and expenditure/expense

accounting principles covered in Chapter 4 is
essential to a sound understanding of
governmental fund accounting, as well as
understanding accounting and financial reporting
for the other governmental funds discussed in the
following chapters
v The General Fund and special revenue funds
encompass most of the operating activities of the
typical government

END
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