CHAPTER TWO

Principles of accounting
& Financial reporting of Governmental
Entities

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Activities of government
Governmental Accounting differs from corporate accounting due to its
focus on accountability and transparency rather than profitability. So, the
principles and practice help ensure accurate, transparent reporting on the
usage and stewardship of public funds.
Governmental activities are diverse and are typically grouped based on
the purpose of spending, source of funds, and the required transparency.
These activities are categorized to clarify the purpose and accountability
of funds.

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Government may involve in three types of activities:

1. Governmental Activities: Although the types and levels of

service vary from government to government, most general
purpose governments provide certain core services: those
related to protection of life and property (e.g., police and fire
protection), public works (e.g., streets and highways, bridges, and
public buildings), parks and recreation facilities and programs, and
cultural and social services.

Example: AA City government builds a new public library using

taxpayers fund. The expenditure for the library is categorized under
Gov’tal activities, as it provides a public service benefiting the
community.
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2. Business-Type Activities: Governments also
engage in business-type activities.
These are gov’t operations that are primarily through users charges rather than
taxes and expected to be self sustaining, Similar to a private business.
These activities include, among others, public utilities (e.g., electric, water,
gas, and sewer utilities), transportation systems, toll roads, toll bridges, hospitals,
parking garages and lots, liquor stores, golf courses, and swimming pools.

Example: AA City water utility department charges residents for water consumption.
The revenue generated covers operating expenses and infrastructure costs.

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3. 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 hears to a deceased individuals estate, and for assets
being held for employee pension plans, among other trustee roles.
Example: A Country manages pension funds for its employees. The funds are held in
trust, and the Gov’t has a fiduciary responsibility to manage them according to trust
agreements.
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 Summary Statement of Governmental Accounting and
Financial Reporting Principles
Accounting & Reporting Capabilities (Principle #1)
A government accounting system must make it possible both:

To present fairly & with full disclosure the financial operation of the
funds & account groups of the governmental unit in conformity with
International public sectors Accounting standards.

To determine & demonstrate compliance with finance-related legal and

contractual provisions.

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Fund Accounting System (principle # 2)
Governmental accounting systems should be organized & operated
on a fund basis.
 “A fund is defined as a fiscal & accounting entity with a self
balancing set of accounts recording cash & other financial
resources, together with all related liabilities & residual equities and
balances, & changes there in, which are segregated for the purpose
of carrying on specifies activities or attaining certain objectives in
accordance with special regulations, restrictions or limitations. ”
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 Fund Accounting System (principle # 2)……..cont..

The word FUND is given special definition as it relates to Fund

Accounting. The narrow definition of Fund as used in ordinary conversation
is a “resource of money” . However in this course it is given the special
definition above. It has key phrases indicating the following points;
It is by itself is an entity
Having its own accounting existence and
A self balancing set of books(double entry system).
The establishment of the fund will attain a specific objective and will
have regulations, restrictions or limitations.

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 Fund Accounting System (principle # 2)……..cont..

Example: To illustrate the concept of fund, we can consider the ministry

of education that operates on several colleges. Although all are part of
the Ministry as a whole each one is treated as a fund.

Each college will be given money that is specifically for its operations,
is not to be mixed up with other institutions.

Therefore each college will keep its own set of books, and issue its own
Financial Reports, irrespective of the performance of other individual
institutions or the ministry as a whole.

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 Types of Funds (Principle # 3)

There are seven types of funds, which are subdivided into three
categories:
I. GOVERNMENTAL FUNDS
1. The General Fund- to account for all financial resources except those
required to be accounted for in another funds.
2. Special Revenue Funds- to accounts for the proceeds of specific
revenue sources (Debt service or for major capital projects) that are
legally restricted to expenditure for specific purposes.

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 Types of Funds (Principle # 3)….cont.

3. Capital Project Fund- to account for financial resources to be used

for the acquisition or construction of major capital facilities (other than
those financed by proprietary & trusts funds) . An example of Capital
Projects Funds could be the construction of new building for the city
government Administration.

4. Debt Service Funds- It is for the accumulation of resources for & the
payment of general long term debt principal & interest.

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Types of Funds (Principle # 3)….cont.

Permanent Funds* - to account for legally restricted resources

provided by trust in which the earnings but not the principal may be
used for purposes that support the primary government’s programs
(those that benefit the government or its citizenry).

Note: Similar permanent trusts that benefit private individuals,

organizations, or other governments—that is, private- purpose trust
funds—are classified as fiduciary funds,
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 Types of Funds (Principle # 3)….cont.

II. PROPRIETARY FUNDS

5. Enterprise Funds- to accounts for operations where the governing body has
decided that periodic determinations of revenues earned, expenses incurred and/
or net income is appropriate for capital maintenance, public policy, management
control, accountability, or other purposes
Example: water fund, Airport fund, Natural gas fund……
6. Internal Service Funds- to account for the financing of goods or services
provided by one department or agency to the another department or agency of the
governmental unit, or to the other governmental units on a cost reimbursement
basis.

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 Types of Funds (Principle # 3)….cont.

Example: A shared garage is a common example of an Internal Service

Fund in government ministry offices. the garage would repair all the
ministries` vehicles regardless of which project, offices or funds uses them
III. FIDUCIARY FUNDS
7. Trust And Agency Funds- To account for assets held by governmental unit
in a trustee capacity or as an agent for individual private organizations, other
governmental units & or funds. These include: Expandable trust funds, Non-
expendable trust funds, Pension trust funds and Agency funds.

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 Number of Funds (Principle # 4)

Governmental units should establishes and maintain those funds

require by law & sound financial administration. only the minimum
number of funds in consistent with legal and operating requirements
should be established, however since unnecessary funds result in
inflexibility, undue complexity & inefficient financial administration.
The seven fund types are to be used if needed by Governmental unit
to demonstrate compliance with legal requirements or if needed to
facilitate sound financial administration.

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 Accounting for fixed assets & long-term liabilities (Principle
#5)
A clear distinction should be made between Fund fixed assets & general
fixed assets & Fund long-term liabilities & General long-term debt.
A. Fixed assets that related to specific property funds & trust funds should
be accounted for through those funds. All other fixed assets of
governmental units should be accounted for through the general fixed asset
account group.
General fixed assets include land, buildings, improvements other than
buildings, car & equipment's used by activities accounted by the four fund
types classified as “governmental funds” .

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 Accounting for fixed assets & long-term liabilities (Principle
#5)…cont.

B. Long term liabilities of proprietary funds & trusts fund

should be accounted for through those funds.
• All other unmatured general long-term liabilities of
governmental unit including special assessments debt for
which the government is obligated in some manner should be
accounted for through the general long-term debt account
group.
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 Valuation of Fixed Assets (PRINCIPLE # 6)

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. ( IPSAS 17).

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 Deprecation of Fixed Assets (PRINCIPLE # 7)
Deprecation of general fixed assets should not be recorded in the
accounts of governmental funds. Deprecation of general fixed assets
may be recorded in cost accounting systems or calculated for cost
finding analysis; & accumulated deprecation may be recorded in the
General Fixed Asset Account group.

Deprecation of fixed assets accounted for in a proprietary funds should

be recorded in accounts of governmental funds. deprecation also
recognized in those trust funds where expenses, net income &/or capital
maintenance are measured.
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 Basis of Accounting (PRINCIPLE # 8)
 The Modified Accrual or accrual basis of accounting as appropriate
should be utilized in measuring financial position & operating results.

A. Governmental fund revenues & expenditures should be recognized on

the modified accrual basis. Revenues should be recognized in the
accounting in which they become available & measurable.
Expenditures should be recognized in the accounting period in which
the fund liability is incurred, if measurable.

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 Basis of Accounting (PRINCIPLE # 8)…cont.
B. Proprietary fund revenues & expenses should be recognized on the
accrual basis.

C. Fiduciary funds revenue and expenses should be recognized on the

basis consistent with the fund’ s accounting measurement objective.

D. Transfers of financial resources among funds should be recognized in

all funds affected in the period in which the inter-fund receivables &
payable(s) arise.

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 Budget and Budgetary Accounting (Principle # 9)
 Budgeting is the process of allocating of resource to meet unlimited
demands and it is key elements of legislative control over governmental
units.

1. An annual budget (s) should be adapted by every governmental units.

2. The accounting system should provide the basis for appropriate

budgetary control.

3. Budgetary comparisons should be included in the appropriate financial

statement & schedules for governmental units funds,
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 Budget and Budgetary Accounting (Principle # 9)…cont.
Budget is importance for the government because of:

1. Reallocation of Resources: Through the budgetary policy, Government aims to

reallocate resources in accordance with the economic (profit maximization) and
social (public welfare) priorities of the country .

2. Reducing inequalities in income and wealth:. It will reduce income of the rich and
raise standard of living of the poor, thus reducing inequalities in the distribution of
income.

3. Economic Stability: Government budget is used to prevent business fluctuations

of inflation or deflation to achieve the objective of economic stability
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 Budget and Budgetary Accounting (Principle # 9)…cont.
Budget is importance for the government because of…..cont.

4. Management of Public Enterprises: Budget is prepared with the objective of

making various provisions for managing such enterprises and providing those
financial help.

5. Economic Growth: It helps to mobilize sufficient resources for investment in the

public sector .

6. Reducing regional disparities: The government budget aims to reduce regional

disparities through its taxation and expenditure policy for encouraging setting up of
production units in economically backward regions.
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 Classification of budget
Budgets classified according to 4 bases; Based on Time; Based on Condition; Based
on Functions; and Based on Flexibility.

1. Based on time factor:

• Budgets can be classified into two types; Long-term Budget, and Short term Budget.

 Long-term Budget : This budget is related to the planning operations of an

organization for a period of 5 to 10 years. The long-term budget may be adversely
affected due to unpredictable factors. Therefore, from a control point of view, the
long-term budget should be supplemented by short term budgets.
Example: Research and Development Budget, Capital Expenditure Budget, etc.

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Cont. ….
 Short-term Budget: This budget is drawn usually for one year . Sometimes a
budget may be prepared for a shorter period (like monthly budget, quarterly
budget, etc.). Short term budgets are prepared in detail and these budgets help to
exercise control over day-to-day operations.
2. Based on Condition: Based on conditions prevailing, a budget can be classified
into two types; Basic Budget, and Current Budget.
 Basic Budget: A budget that is established for use as unaltered over a long
period.
• This budget does not take into consideration changes occurring from the
external environment which are beyond the control of management. This budget
is more useful
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Cont. ….
 Current Budget: A budget that is established for use over a short period and is
related to the current conditions is called the Current Budget. This budget is
adjusted to the current conditions prevailing in the business.
3. Based on Functions: Based on activities or functions of a business, budgets
can be classified into 2 types Master Budget, and Functional Budgets.
 Master Budget: The final integration of all functional budgets by the Budget
Officer provides the Master Budget. When functional budgets have been
completed, the Budget Officer prepares the Master Budget. It is the summary
budget incorporating its component functional budgets, which is finally
approved, adopted and employed.
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Cont. ….
• Master Budget shows the operating profit of the business for the
budget period and budgeted balance sheet at its close. This Budget
portrays the overall plan for the budget period and it consists of
several separate but interdependent budgets.
 Functional Budgets: Functional Budgets relate to functions of the
business such as product sales etc. In other words, Functional
Budgets are prepared in respect of various functions performed in a
business.

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Cont. ….
• Functional Budgets which are commonly found in a business concern are ;
Sales Budget; Production Budget; Material Budget; Labor Budget;
Production Overhead Budget; Administration Overhead Budget; Selling &
Distribution Overhead Budget; Plant Utilization Budget; Cash Budget,
Research & Development Budget and more

4. Based on Flexibility: Based on flexibility budgets can be classified into two

types; Fixed Budget, and Flexible Budget.
• Fixed Budget (or Static Budget): Fixed Budget is a budget which is
designed to remain unchanged irrespective of the level of activity attained.

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Cont. ….
• This type of budget is most suited for Fixed expenses, which have no relation to the
volume of output. Fixed -Budget is ineffective as a tool for cost control. Fixed Budget is
based on the assumption that the volume of output and sales can be anticipated with a
fair degree of accuracy .
 Flexible Budget (or Sliding Scale Budget): Flexible Budget is a budget which is designed to
change by the level of activity attained.
• This budget recognizes the difference in behavior between fixed and variable costs about
fluctuations in output. It serves as a useful tool for controlling costs. It is more realistic,
practical and useful than Fixed Budget.
• A flexible budget that can be used to estimate what costs should be for any level of
activity within a specified range. A flexible budget shows what costs should be for various
levels of activity .
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 Financial Reporting (Principal # 10)
1. Appropriate interim financial statements & reports of financial position,
operating results & other pertinent information should be prepared to
facilitate management control of financial operations, legislative oversight
& where necessary or desired for external reporting purpose.

2. A comprehensive annual financial report covering all funds & account

gropes of the governmental unit including appropriate combined,
combining & individual fund statements, notes to the F .S, schedules,
narrative explanations & statistical tables should be prepared & published

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