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CHAPTER 7: ACCOUNTING FOR THE BUSINESS-TYPE ACTIVITIES OF STATE AND LOCAL GOVERNMENTS
7-13
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CHAPTER 7: ACCOUNTING FOR THE BUSINESS-TYPE ACTIVITIES OF STATE AND LOCAL GOVERNMENTS
Answers to Questions
7-1. Proprietary funds are funds that are supported by user charges, and therefore require reporting that illustrates whether user charges are covering costs. They are often described as being operated more like a business than most governmental funds, and the reporting is similar to that of for-profit organizations.
There are two basic types of proprietary funds: internal service funds and enterprise funds. Internal service funds are generally used for activities where centralization of a service or function is likely to result in efficiency and/or cost effectiveness. The customers of internal service funds would generally be within the government itself. Examples would include information systems or purchasing. An enterprise fund carries on activities that provide goods or services to the general public, such as a public swimming pool. These activities are referred to as business-type activities. Under GASB Codification Section 1300.109, a government must report business-type activities in an enterprise fund if any of the following criteria are met: (1) The activity is financed with debt that is secured solely by a pledge of the revenues from fees and charges of an activity; (2) Laws or regulations require that the activity’s costs of providing services, including capital costs (such as depreciation or debt service), be recovered with fees and charges, rather than with taxes or similar revenues; or (3) Pricing policies are designed to recover the costs of the activity, including capital costs.
General Problem Information: Proprietary funds
Learning Objective: 7-1
Topic: Proprietary funds
Bloom’s Taxonomy: Remember
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting Level of Difficulty: Easy
7-2. Internal service funds and enterprise funds are presented in three proprietary fund financial statements a statement of net position; a statement of revenues, expenses and changes in fund net position; and a statement of cash flows. Those enterprise funds considered to be major funds are presented in separate columns of the proprietary fund financial statements, with nonmajor enterprise funds aggregated in an Other Enterprise Funds column. All internal service funds are aggregated and reported in a single column on the fund statements. At the government-wide level the internal service funds balances are essentially collapsed into the Government Activities column of the government-wide statements. Enterprise funds are considered business-type activities and are reported in the Business-type Activities column of the government-wide statements.
Ch. 7, 7-1 (Cont’d)
Internal service funds and enterprise funds are both proprietary funds and are presented as such in the funds financial statements. However, since the transactions of internal service funds primarily involve sales of goods or services to the General Fund and other funds that compose the governmental activities of a government, their financial balances are included in a single column of the proprietary fund financial statements. As described in the chapter, internal service fund financial information is “collapsed” into and reported in the Governmental Activities column, while enterprise funds are reported in the Business-type Activities column of both government-wide financial statements.
General Problem Information: Internal service and enterprise funds
Learning Objective: 7-2
Learning Objective: 7-3
Topic: Proprietary funds
Bloom’s Taxonomy: Remember
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Easy
7-3. Disagree The main purchasers of the internal service fund’s services are the city’s governmental funds. As shown in Illustration 7-4, the city commission has budgetary authority over the General Fund and other budgetary funds that will be using internal services. Through its approval of the budgets for these funds, the commission is able to control the resources flowing to the city’s internal service funds.
General Problem Information: Budgetary control of internal service funds
Learning Objective: 7-4
Learning Objective: 7-6
Topic: Special Topics Associated with Internal Service Funds
Bloom’s Taxonomy: Understand
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Easy
7-4. A proprietary fund prepares a statement of net position, a statement of revenues, expenses and changes in fund net position, and a statement of cash flows. The statement of net position can be compared to a for-profit organization’s balance sheet. The format for the statement of net position differs from a balance sheet, largely because there is no equity in a proprietary fund. Instead of using the basic accounting equation format where total assets equal total liabilities plus equity, the statement of net position subtracts liabilities and deferred inflow of resources from assets and deferred outflow of resources to arrive at an ending number called “net position.” Furthermore, net position is reported in three components: net investment in capital assets, restricted, and unrestricted.
Ch. 7, 7-4 (Cont’d)
The statement of revenues, expenses, and changes in net position can be compared to a for-profit organization’s income statement. One difference is that a for-profit organization does not net items like bad debts from the related revenue as a proprietary fund does. Also, revenues and expenses are required to be identified as operating and non-operating. Finally, the statement may include items such as interfund transfers and capital contributions which are unique to governmental accounting.
The statement of cash flows for a proprietary fund differs somewhat from the statement of cash flows for a for-profit organization. GASB requires the direct approach for preparing the statement, and, instead of three categories (operating, investing, and financing), a proprietary fund reports four categories: operating, noncapital financing, capital and related financing, and investing. Finally, the categories of cash flows are defined differently. For example, the acquisition of a capital asset is an investing activity in for-profit, and it is a capital and related financing activity in government.
General Problem Information: Proprietary funds vs. for-profit reporting
Learning Objective: 7-3
Topic: Financial Reporting Requirements
Bloom’s Taxonomy: Understand
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Easy
7-5. Restricted assets are assets that have been segregated, pursuant to an agreement with an external party or by law or regulation, for a specified purpose and therefore are not available for the discretionary use of management. Items typically reported in the "Restricted Assets" section of the statement of fund net position include assets set aside for retirement of revenue bonds in conformity with bond covenants and bond proceeds, grants, and contributions restricted for capital purposes. Customer deposits or resources held for the retirement of revenue bonds are commonly reported as restricted assets by government utilities that use proprietary fund accounting.
General Problem Information: Restricted assets of enterprise funds
Learning Objective: 7-5
Learning Objective: 7-6
Topic: Restricted Assets
Bloom’s Taxonomy: Remember
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting
Level of Difficulty: Easy
Ch. 7, 7-6 (Cont’d)
7-6. GASB Codification Section 2200.118-125 provides the following three components for the classification of net position: net investment in capital assets, restricted, and unrestricted. Net investment in capital assets is calculated as the total of gross capital assets, net of accumulated depreciation, less any outstanding debt related to the acquisition or construction of capital assets. If debt has been incurred for construction or acquisition of a capital asset, but the proceeds of the debt have not been spent by yearend, that debt is excluded in calculating net investment in capital assets. Restricted net position represents those net resources with restrictions on use imposed by law or external parties; while unrestricted net position represents the residual amount of net position after separately identifying net investment in capital assets and restrictions.
General Problem Information: Components of net position
Learning Objective: 7-3
Topic: Statement of Net Position
Bloom’s Taxonomy: Remember
Accreditation Skills tag: AACSB: Communication, AICPA: FN Reporting Level of Difficulty: Easy
7-7. Since an internal service fund is basically operated on a business basis, the amount it charges for goods and services should also be able to finance the replacement, modernization, and expansion of plant and equipment used in fund operations. Thus the internal service fund can recover more than its costs – that is, it can recover “full cost, ” as long as prices charged by the fund are less than the using funds and departments would have to pay outside vendors for equivalent products and services. If an internal service fund recovers more than its “full cost” through user charges, the paying fund should report the payment as an other financing use, while the internal service fund would record it as a nonoperating transfer. If the internal service fund does not recover sufficient amounts to cover costs, the accumulated fund deficit should be charged to other funds, where it should be reported as an expenditure or expense.
General Problem Information: Internal service funds
Learning Objective: 7-4
Learning Objective: 7-6
Topic: Internal Service Funds
Bloom’s Taxonomy: Understand
Accreditation Skills tag: AACSB: Knowledge Application, AICPA: FN Reporting Level of Difficulty: Medium
