Chapter Nineteen. Governmental Entities: Proprietary Funds, Fiduciary Funds, and Comprehensive Annual Financial Report PROPRIETARY FUNDS

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1 Chapter Nineteen Governmental Entities: Comprehensive Annual Financial Report Scope of Chapter In this chapter, the coverage of accounting and reporting for governmental entities is completed with the discussion and illustration of (1) accounting and reporting for proprietary funds and fiduciary funds, and (2) the comprehensive annual financial report (CAFR) currently published by governmental entities other than the federal government. PROPRIETARY FUNDS 780 Enterprise funds and internal service funds constitute the proprietary funds of governmental entities. These funds are more similar to business enterprises than are governmental funds or fiduciary funds (trust funds and agency funds). Enterprise funds sell services to the citizens, and sometimes to other funds, of the governmental entity, for amounts designed to produce a net income. Internal service funds, as their title indicates, sell goods or services to other funds of the governmental entity, but not to the public. Accordingly, earning significant amounts of net income is not an objective of an internal service fund. Both enterprise funds and internal service funds use the accrual basis of accounting and issue financial statements similar to those for a nonprofit organization a statement of revenues, expenses, and changes in net assets [which includes an amount labeled increase (decrease) in net assets], a statement of net assets, and a statement of cash flows.

2 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 781 The statements of net assets of both types of proprietary funds are classified into current and noncurrent sections. The plant assets of the two types of proprietary funds are recorded in their accounting records, and depreciation and amortization expenses are recognized by each proprietary fund. Because of the many similarities in the accounting cycle and the financial statements of business enterprises and proprietary funds, journal entries for proprietary funds are not illustrated in this section. Instead, the unique features of proprietary funds, including differences from features of business enterprises, are emphasized, and financial statements for proprietary funds are illustrated. Accounting and Reporting for Enterprise Funds Enterprise funds account for the operations of commercial-type activities of a governmental entity, such as utilities, airports, seaports, and recreational facilities. These commercialtype enterprises sell services to the public (and sometimes to other activities of the governmental entity) at a profit. Consequently, the accounting for enterprise funds is more akin to business enterprise accounting than the accounting for any other governmental entity fund. For example, the accrual basis of accounting is used for an enterprise fund, with short-term prepayments, depreciation expense, and doubtful accounts expense recognized in the fund s accounting records. The enterprise fund s accounting records also include the plant assets owned by the fund, as well as the liabilities for revenue bonds and any general obligation bonds payable by the fund. (General obligation bonds are a liability of an enterprise fund if their proceeds were used by the enterprise fund for construction of plant assets or other purposes.) Encumbrance accounting is not used for enterprise funds, and their annual budgets generally are not entered in the accounting records. The net assets of an enterprise fund may be debited with cash remittances for transfers to the general fund, similar to dividends declared and paid by a corporate enterprise. However, there are several differences between accounting for an enterprise fund and accounting for a business enterprise. Among these differences are the following: 1. Enterprise funds are not subject to federal and state income taxes. However, an enterprise fund may make payments in lieu of property or franchise taxes to the general fund and display the payments as expenses in the statement of revenues, expenses, and changes in net assets. (See page 727 of Chapter 17.) 2. There is no capital stock in an enterprise fund s statement of net assets. 3. An enterprise fund has restricted assets, which are segregated from current assets in the balance sheet. Cash deposits made by customers of a utility enterprise fund, which are to help assure the customers payment for utility services, are restricted for cash or interest-bearing investments to offset the enterprise fund s liability for the customers deposits. Cash received from proceeds of revenue bonds issued by the enterprise fund is restricted to payments for construction of plant assets financed by issuance of the bonds. Part of the cash generated by the enterprise fund s operations must be segregated and invested for payment of interest and principal of the revenue bonds issued by the enterprise fund. 4. Current liabilities payable from restricted assets are segregated from other current liabilities of an enterprise fund in a section of the balance sheet that precedes long-term liabilities. 5. A restricted net assets amount generally is displayed in the statement of net assets of an enterprise fund. The amount is equal to the total of cash and investments restricted to payment of revenue bond interest and principal.

3 782 Part Five Accounting for 6. Subsidy-type transfers from an enterprise fund to the general fund are displayed below nonoperating revenues and expenses of the enterprise fund s statement of revenues, expenses, and changes in net assets. 7. The form of the statement of cash flows for proprietary funds of governmental entities was set forth in GASB Statement No. 9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting, issued in 1989 by the Governmental Accounting Standards Board. 1 Among the features of an enterprise fund s statement of cash flows are the following: a. There are four categories of cash flows: from operating activities, from noncapital financing activities, from capital and related financing activities, and from investing activities. (The statement of cash flows for a business enterprise has three categories of cash flows.) b. In the direct method, operating income, rather than increase (decrease) in net assets, is reconciled to net cash provided by operating activities. The direct method is required. c. Noncapital financing activities cash flows include operating grants from other governmental entities and transfers to or from other funds of the governmental entity. d. Temporary investments of cash received from borrowings for plant assets construction are reported with cash flows from capital and related financing activities, rather than with cash flows from investing activities. Financial Statements for Enterprise Fund Some of the foregoing discussion is illustrated in the following financial statements of the Town of Verdant Glen Enterprise Fund (for the town s water utility): Financial Statements of a Governmental Entity s Enterprise Fund TOWN OF VERDANT GLEN ENTERPRISE FUND Statement of Revenues, Expenses, and Changes in Net Assets For Year Ended June 30, 2006 Operating revenues: Charges for services $520,000 Operating expenses: Personal services $ 82,000 Contractual services 94,000 Supplies 21,000 Material 75,000 Heat, light, and power 14,000 Depreciation 45,000 Payment in lieu of property taxes 40,000 Total operating expenses 371,000 Operating income $149,000 Nonoperating revenues (expenses): Operating grants $ 43,000 Investment revenue and net gains 12,000 Interest expense (46,000) Fiscal agent fees (14,000) Total nonoperating revenues (expenses) (5,000) (continued) 1 Codification of Governmental Accounting and Financial Reporting Standards (Norwalk: GASB, 2003), Sec

4 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 783 TOWN OF VERDANT GLEN ENTERPRISE FUND Statement of Revenues, Expenses, and Changes in Net Assets (concluded) For Year Ended June 30, 2006 Income before transfers $144,000 Transfer (out) to General Fund (10,000) Increase in net assets $134,000 Net assets, beginning of year 532,000 Net assets, end of year $666,000 TOWN OF VERDANT GLEN ENTERPRISE FUND Statement of Net Assets June 30, 2006 Assets Current assets: Cash $ 62,000 Short-term investments, at fair value 120,000 Accounts receivable (net) 56,000 Receivable from General Fund 5,000 Inventory of supplies, at first-in, first-out cost 18,000 Short-term prepayments 2,000 Total current assets $ 263,000 Restricted assets: Cash $ 22,000 Short-term investments, at fair value 145,000 Total restricted assets $ 167,000 Capital assets: Land $ 192,000 Buildings 1,285,000 Machinery and equipment 347,000 Subtotal 1,824,000 Less: Accumulated depreciation 748,000 Net capital assets 1,076,000 Total assets $1,506,000 Liabilities Current liabilities: Vouchers payable $ 144,000 Accrued liabilities 82,000 Total current liabilities $ 226,000 Liabilities payable from restricted assets: Interest payable $ 20,000 Current portion of revenue bonds 50,000 Customers deposits 44,000 Total liabilities payable from restricted assets $ 114,000 Long-term debt: Revenue bonds, less current portion 500,000 Total liabilities $ 840,000 (continued)

5 784 Part Five Accounting for TOWN OF VERDANT GLEN ENTERPRISE FUND Statement of Net Assets (concluded) June 30, 2006 Net Assets Net assets: Invested in capital assets, net of related debt Restricted for debt service Unrestricted $526,000 (a) 103,000 (b) 37,000 (c) Total net assets $666,000 (a) $1,076,000 $50,000 $500,000 (b) $167,000 $20,000 $44,000 (c) $1,506,000 $840,000 $526,000 $103,000, OR $263,000 $226,000 TOWN OF VERDANT GLEN ENTERPRISE FUND Statement of Cash Flows For Year Ended June 30, 2006 Net cash provided by operating activities (Exhibit 1): Cash receipts from customers $782,000 Cash receipts from interfund services provided 87,000 Total cash receipts $869,000 Cash payments to employees for services $314,000 Cash payments to other suppliers of goods or services 203,000 Cash payment in lieu of property taxes to General Fund 40,000 Other operating cash payments 108,000 Total cash payments 665,000 Net cash provided by operating activities $204,000 Cash flows from noncapital financing activities: Payment of principal ($50,000) and interest ($2,000) of note payable to bank $ (52,000) Operating grants from state government 43,000 Transfer (out) to General Fund (10,000) Net cash used in noncapital financing activities (19,000) Cash flows from capital and related financing activities: Acquisition of machinery and equipment $ (41,000) Payment of serial maturity of revenue bonds ($50,000) and annual interest on the bonds ($44,000) (94,000) Payment of fiscal agent fees (14,000) Deposits received from customers 10,000 Net cash used in capital and related financing activities (139,000) Cash flows from investing activities: Revenue and net gains from short-term investments 12,000 Increase in cash and cash equivalents $ 58,000 Cash and cash equivalents, beginning of year 291,000 Cash and cash equivalents, end of year $349,000 (continued)

6 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 785 TOWN OF VERDANT GLEN ENTERPRISE FUND Statement of Cash Flows (concluded) For Year Ended June 30, 2006 Exhibit 1 Cash flows from operating activities: Operating income $149,000 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation expense 45,000 Decrease in accounts receivable (net) 3,000 Increase in receivable from General Fund (5,000) Increase in inventory of supplies (4,000) Decrease in short-term prepayments 1,000 Increase in vouchers payable 21,000 Decrease in accrued liabilities (6,000) Net cash provided by operating activities $204,000 The following four aspects of the financial statements for the Town of Verdant Glen Enterprise Fund should be noted: 1. The payment in lieu of property taxes, $40,000, and the transfer out, $10,000, in the statement of revenues, expenses, and changes in net assets are counterparts of the amounts recorded by the Town of Verdant Glen General Fund in journal entry no. 9 on page 727 of Chapter The receivable from General Fund, $5,000, in the statement of net assets is the counterpart of the related payable to Enterprise Fund in the General Fund trial balance on page 729 of Chapter The $103,000 net assets restricted for revenue bonds retirement in the statement of net assets may be verified as follows: Total restricted assets $167,000 Less: Total liabilities payable from restricted assets other than long-term debt 64,000 Net assets restricted for revenue bonds retirement $103, Short-term investments, both current and restricted, in the statement of net assets are cash equivalents. Thus, the end-of-year amount of cash and cash equivalents in the statement of cash flows is computed as follows: $62,000 $120,000 $22,000 $145,000 $349,000. Accounting and Reporting for Internal Service Funds An internal service fund is established to sell supplies and services to other funds of the governmental entity, but not to the public. This type of fund is created to ensure uniformity and economies in the procurement of supplies and services for the governmental entity as a whole, such as computer and stationery supplies and the maintenance and repairs of motor vehicles. The operations of internal service funds resemble those of a business enterprise, except that internal service funds are not profit-motivated. The revenues of internal service funds should be sufficient to cover all their operating costs and expenses, with perhaps a modest profit margin. In this way, the resources of internal service funds are revolving ; the original contribution from the general fund of the governmental entity to establish an internal

7 786 Part Five Accounting for service fund is expended for supplies, operating equipment, employees salaries or wages, and other operating expenses, and the amounts expended then are recouped through billings to other funds of the governmental entity. Although an internal service fund should use an annual budget for managerial planning and control purposes, the budget need not be entered in the accounting records of the fund. The accrual basis of accounting, including the perpetual inventory system and depreciation of plant assets, is appropriate for an internal service fund. Encumbrance accounting may be useful in controlling nonrecurring purchase orders of an internal service fund. Because internal service funds do not issue revenue bonds and do not receive contributions or deposits from customers, the financial statements of internal service funds are nearly identical in form and content to those of business enterprises. However, similar to enterprise funds, internal service funds do not have owners equity in their statements of net assets. A net assets ledger account balance typically supports that amount in the net assets section of the statement of net assets for an internal service fund. Financial Statements for Internal Service Fund The following financial statements for the Town of Verdant Glen Internal Service Fund are illustrative of the statements for such a fund. The receivable from General Fund, $6,000, in the statement of net assets below is the counterpart of the related payable to Internal Service Fund in the General Fund trial balance on page 729 of Chapter 17. Financial Statements of a Governmental Entity s Internal Service Fund TOWN OF VERDANT GLEN INTERNAL SERVICE FUND Statement of Revenues, Expenses, and Changes in Net Assets For Year Ended June 30, 2006 Operating revenues: Charges for services $162,400 Operating expenses: Personal services $21,200 Supplies 84,300 Heat, light, and power 20,500 Depreciation 34,000 Total operating expenses 160,000 Increase in net assets $ 2,400 Net assets, beginning of year 636,800 Net assets, end of year $639,200 TOWN OF VERDANT GLEN INTERNAL SERVICE FUND Statement of Net Assets June 30, 2006 Assets Current assets: Cash $ 8,600 Receivable from General Fund 6,000 Inventory of supplies, at first-in, first-out cost 64,300 Total current assets $ 78,900 (continued)

8 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 787 TOWN OF VERDANT GLEN INTERNAL SERVICE FUND Statement of Net Assets (concluded) June 30, 2006 Capital assets: Land $ 142,100 Building 627,500 Machinery and equipment 132,800 Subtotal 902,400 Less: Accumulated depreciation 327,800 Net capital assets 574,600 Total assets $ 653,500 Liabilities Current liabilities: Vouchers payable $ 14,300 Total liabilities $ 14,300 Net Assets Net assets: Invested in capital assets, net of related debt $ 574,600 Unrestricted 64,600 (a) Total net assets $ 639,200 (a) $78,900 $14,300 TOWN OF VERDANT GLEN INTERNAL SERVICE FUND Statement of Cash Flows For Year Ended June 30, 2006 Net cash provided by operating activities (Exhibit 1): Cash receipts from interfund services provided $370,300 Cash payments to employees for services $ 76,000 Cash payments to other suppliers of goods or services 212,000 Other operating cash payments 53,600 Total cash payments 341,600 Net cash provided by operating activities $ 28,700 Cash flows from capital and related financing activities: Acquisition of machinery and equipment (23,400) Increase in cash $ 5,300 Cash, beginning of year 3,300 Cash, end of year $ 8,600 Exhibit 1 Cash flows from operating activities: Increase in net assets $ 2,400 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Depreciation expense 34,000 Decrease in receivable from General Fund 1,000 Increase in inventory of supplies (11,300) Increase in vouchers payable 2,600 Net cash provided by operating activities $ 28,700

9 788 Part Five Accounting for FIDUCIARY FUNDS Applicability of FASB Pronouncements to Proprietary Funds In GASB Statement No. 20, Accounting and Financial Reporting for Proprietary Funds..., the GASB addressed the troublesome issue of which if any pronouncements of the FASB should apply to proprietary funds of governmental entities. 2 As an interim measure, the GASB provided that proprietary funds should apply all Accounting Research Bulletins, Accounting Principles Board Opinions, and Financial Accounting Standards Board Statements and Interpretations issued as of November 30, 1989, unless those pronouncements conflicted with or contradicted GASB pronouncements. In addition, proprietary funds might elect to apply all (not some) FASB Statements and Interpretations issued after November 30, 1989, as long as they do not conflict with or contradict GASB pronouncements. Thus, GASB Statement No. 20 provided temporary guidance to governmental entities for applying business enterprise-type accounting standards, as appropriate, to their proprietary funds. In GASB Statement No. 34, Basic Financial Statements..., paragraphs 93 through 95, the GASB reaffirmed the foregoing provisions of GASB Statement No. 20. Private-purpose trust funds, pension trust funds, agency funds, and investment trust funds constitute the fiduciary funds of a governmental entity. The position of the governmental entity with respect to such funds is one of a custodian or a trustee, rather than an owner. For fiduciary funds, the Governmental Accounting Standards Board has mandated use of the accrual basis of accounting and preparation of a statement of fiduciary net assets and a statement of changes in fiduciary net assets. 3 The following sections of this chapter describe and illustrate accounting and reporting for fiduciary funds. Accounting and Reporting for Agency Funds Agency funds are of short duration. Typically, agency funds are used to account for sales taxes collected by a state government on behalf of the municipalities and townships of the state, and for payroll taxes and other deductions withheld from salaries and wages payable to employees of a governmental entity. The amounts withheld subsequently are paid to a federal or state collection unit. Agency funds do not have operations during a fiscal year; thus, the only financial statements for an agency fund are a statement of fiduciary assets showing the cash or receivables of the fund and the amounts payable to other funds or governmental entities or to outsiders, and a statement of changes in fiduciary assets, illustrated as follows for the Town of Verdant Glen: Financial Statements of a Governmental Entity s Agency Fund TOWN OF VERDANT GLEN AGENCY FUND Statement of Fiduciary Assets June 30, 2006 Assets Cash $12,600 Liabilities Vouchers payable $12,600 2 Ibid., Sec. P and P Ibid., Sec. 1600, Fund Financial Statements, C, and Sec Sec

10 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 789 TOWN OF VERDANT GLEN AGENCY FUND Statement of Changes in Assets and Liabilities For Year Ended June 30, 2006 Balances, Balances, July 1, 2005 Additions Deductions June 30, 2006 Assets Cash $14,200 $49,000 $50,600 $12,600 Liabilities Vouchers payable $14,200 $49,000 $50,600 $12,600 Accounting and Reporting for Private-Purpose Trust Funds Private-purpose trust funds of a governmental entity are longer-lived than agency funds. An expendable trust fund is one whose principal and income both may be expended to achieve the objectives of the trust. A nonexpendable trust fund is one whose revenues are expended to carry out the objectives of the trust; the principal remains intact. For example, an endowment established by the grantor of a trust may specify that the revenues from the endowment are to be expended by the governmental entity for student scholarships, but the endowment principal is not to be expended. A nonexpendable trust fund requires two separate trust fund accounting entities one for principal and one for revenues. Accounting for the two separate trust funds requires a careful distinction between transactions affecting the principal such as changes in the investment portfolio and transactions affecting revenues such as cash dividends and interest on the investment portfolio. The trust indenture, which is the legal document establishing the trust, should specify distinctions between principal and revenues. If the trust indenture is silent with respect to such distinctions, the trust law of the governmental entity governs separation of principal trust fund and revenues trust fund transactions. Because the governmental entity serves as a custodian for a trust fund, accounting for a trust fund should comply with the trust indenture under which the fund was established. Among the provisions that might affect the accounting for a trust fund are requirements that the annual budget for the trust fund be entered in its accounting records and that depreciation be recognized for an endowment principal trust fund that includes depreciable plant assets. To illustrate accounting for private-purpose trust funds, assume that Karl and Mabel Root, residents of the Town of Verdant Glen, contributed marketable securities with a current fair value of $100,000 on July 1, 2005, to a trust to be administered by the Town of Verdant Glen as trustee. Principal of the gift was to be maintained in an Endowment Principal Nonexpendable Trust Fund. Revenues from the marketable securities were to be used for scholarships for qualified students to attend Verdant Glen College; the revenues and expenditures for scholarships were to be accounted for in an Endowment Revenues Expendable Trust Fund. The Bank of Verdant Glen trust department was to receive an annual trustee s fee of $500 for administering the two trust funds on behalf of the Town of Verdant Glen. Journal entries for the two trust funds for the year ended June 30, 2006, are summarized on page 790 (changes in current fair value of the marketable securities are disregarded).

11 790 Part Five Accounting for Journal Entries for Nonexpendable Trust Fund and Expendable Trust Fund of a Governmental Entity Endowment Endowment Principal Revenues Nonexpendable Expendable Explanation of Transactions and Events Account Titles Trust Fund Trust Fund Receipt of marketable securities in trust Investments 100,000 Revenues 100,000 Accrual of revenues on marketable Interest Receivable 5,000 securities Dividends Receivable 8,000 Revenues 13,000 Receipt of interest and dividends Cash 13,000 Interest Receivable 5,000 Dividends Receivable 8,000 Recording of liability to Revenues Trust Other Financing Uses 13,000 Fund for interest and dividends Payable to Revenues Trust Fund 13,000 Receivable from Principal Trust Fund 13,000 Other Financing Sources 13,000 Transfer of cash from Principal Trust Fund to Payable to Revenues Trust Fund 13,000 Revenues Trust Fund Cash 13,000 Cash 13,000 Receivable from Principal Trust Fund 13,000 Payment of scholarships to students James Expenditures 12,000 Rich and Janet Wells Cash 12,000 Payment of trustee s fee Expenditures 500 Cash 500 Closing entries Revenues 113,000 Other Financing Uses 13,000 Net assets Reserved for Endowment 100,000 Other Financing Sources 13,000 Expenditures 12,500 Net assets Reserved for Scholarships 500

12 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 791 Financial Statements of Nonexpendable Trust Fund Financial statements of the Town of Verdant Glen Endowment Principal Nonexpendable Trust Fund are shown below for the year ended June 30, 2006: Financial Statements of a Governmental Entity s Nonexpendable Trust Fund TOWN OF VERDANT GLEN ENDOWMENT PRINCIPAL NONEXPENDABLE TRUST FUND Statement of Changes in Fiduciary Net Assets For Year Ended June 30, 2006 Operating revenues: Interest $ 5,000 Dividends 8,000 Gifts 100,000 Total operating revenues $113,000 Transfers out 13,000 Increase in net assets $100,000 Net assets, beginning of year -0- Net assets, end of year $100,000 TOWN OF VERDANT GLEN ENDOWMENT PRINCIPAL NONEXPENDABLE TRUST FUND Statement of Fiduciary Net Assets June 30, 2006 Assets Investments, at fair value $100,000 Net Assets Net assets reserved for endowment $100,000 Financial Statements of Expendable Trust Fund For the Town of Verdant Glen Endowment Revenues Expendable Trust Fund, financial statements for the year ended June 30, 2006, are as follows: Financial Statements of a Governmental Entity s Expendable Trust Fund TOWN OF VERDANT GLEN ENDOWMENT REVENUES EXPENDABLE TRUST FUND Statement of Changes in Fiduciary Net Assets For Year Ended June 30, 2006 Revenues $ -0- Expenditures: Education $ 12,000 Administration 500 Total expenditures $ 12,500 Excess (deficiency) of revenues over expenditures $(12,500) Transfers in 13,000 Increase in net assets $ 500 Net assets, beginning of year -0- Net assets, end of year $ 500

13 792 Part Five Accounting for TOWN OF VERDANT GLEN ENDOWMENT REVENUES EXPENDABLE TRUST FUND Statement of Fiduciary Net Assets June 30, 2006 Assets Cash $500 Net Assets Net assets $500 There is no unreserved and undesignated net assets balance for either of the Town of Verdant Glen trust funds, because the trust indenture required the reservation of the entire net assets of each fund to achieve the purpose of the trust. Accounting and Reporting for Pension Trust Funds The GASB has defined a pension trust fund as follows: A fund used by a governmental entity to report resources that are required to be held in trust for the members and beneficiaries of defined benefit pension plans, defined contribution plans, other postemployment benefit plans, or other employee benefit plans. They are used to account for the accumulation of assets for the purpose of paying benefits when they become due in accordance with the terms of the plan: a pension plan included in the financial reporting entity of the plan sponsor or a participating employer. 4 Pension trust funds are accounted for in essentially the same manner as proprietary funds. Thus, the accounting records of pension trust funds are maintained under the accrual basis of accounting and include all assets, liabilities, revenues, and expenses of the fund. Because of the complexities of pension trust funds, illustrative journal entries for a pension trust fund are beyond the scope of this discussion. The following financial statements for the Town of Verdant Glen Employees Retirement System Pension Trust Fund for the year ended June 30, 2006, which exclude a statement of cash flows (which is optional) illustrate some of the accounting concepts involved. 5 TOWN OF VERDANT GLEN PENSION TRUST FUND Statement of Changes in Fiduciary Net Assets For Year Ended June 30, 2006 Additions: Employee contributions $131,600 Employer contributions 247,300 Investment net gains and revenues, net of investment expenses 146,200 Total additions $525,100 Deductions: Annuity and disability benefits $222,000 Refunds of contributions 38,300 Administrative expenses 187,200 Total deductions 447,500 Increase in net assets $ 77,600 Net assets held in trust for pension benefits, beginning of year 842,300 Net assets held in trust for pension benefits, end of year $919,900 4 Ibid., Sec. P Ibid., Sec. Pe5.901.

14 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 793 TOWN OF VERDANT GLEN PENSION TRUST FUND Statement of Fiduciary Net Assets June 30, 2006 Assets Cash and short-term investments, at fair value $ 21,200 Receivables 34,800 Long-term investments, at fair value 884,600 Capital assets, less accumulated depreciation 82,100 Total assets $1,022,700 Liabilities Refunds payable and other 102,800 Net assets held in trust for pension benefits $ 919,900 In addition to the foregoing financial statements, the pension trust fund of a governmental entity must provide two schedules as required supplementary information following the notes to the pension fund s financial statements: A schedule of funding progress that includes historical trend information about the actuarially determined funded status of the pension plan and the progress made in accumulating sufficient assets to pay benefits when due A schedule of employer contributions that includes historical trend information about the annual required contributions compared with the actual contributions 6 Following is a discussion of important features of the financial statements for the Town of Verdant Glen Pension Trust Fund: 1. The defined benefit pension plan of the Town of Verdant Glen is a contributory pension plan, to which both covered employees and the town make contributions. (In a noncontributory pension plan, only the town would make contributions.) 2. Investment revenues of the Pension Trust Fund include realized and unrealized gains and losses on investments as well as interest and dividends. 3. Annuity benefits are pension payments to retired former employees of the Town of Verdant Glen. Disability benefits are payments to former employees whose disabilities precluded their working until scheduled retirement dates. 4. All pension payments to retired employees had been made through June 30, 2006; otherwise, the liabilities in the Pension Trust Fund statement of fiduciary net assets would include an amount for annuities payable. 5. Not illustrated for the Town of Verdant Glen Pension Trust Fund are the extensive disclosures required in notes to the financial statements of the Pension Trust Fund. These required disclosures are set forth in GASB Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, paragraph 32. Accounting and Reporting for Investment Trust Funds Governmental entities such as counties and states often maintain external investment pools, similar to the pooled investments of the various funds of nonprofit organizations discussed in Chapter 16. Smaller governmental entities, such as towns and villages located 6 Ibid.

15 794 Part Five Accounting for in the same county or state, may achieve higher returns by pooling their investments with those of other small entities. The investments are managed by the treasurer or chief financial officer of the state or county sponsoring government. In GASB Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, the GASB required sponsoring governments to establish investment trust funds for external investment pools. Financial statements for the investment pools would be the same as for pension trust funds: a statement of fiduciary net assets and a statement of changes in fiduciary net assets. 7 To illustrate, assume that Riparian County maintains an external investment pool for the Town of Verdant Glen and other towns and villages within its borders. Following are hypothetical financial statements for the Riparian County Investment Trust Fund: RIPARIAN COUNTY INVESTMENT TRUST FUND Statement of Changes in Fiduciary Net Assets For Year Ended June 30, 2006 Additions: Participants contributions $ 1,800,000 Investment net realized and unrealized gains and revenues, net of investment expenses 1,140,000 Total additions $ 2,940,000 Deductions: Administrative expenses 460,000 Net increase $ 2,480,000 Net assets held in trust for pool participants, beginning of year 65,820,000 Net assets held in trust for pool participants, end of year $68,300,000 RIPARIAN COUNTY INVESTMENT TRUST FUND Statement of Fiduciary Net Assets June 30, 2006 Assets Cash and short-term investments, at fair value $26,200,000 Long-term investments at, fair value 42,180,000 Total assets $68,380,000 Liabilities Payable to Treasurer of Riparian County 80,000 Net assets held in trust for pool participants $68,300,000 COMPREHENSIVE ANNUAL FINANCIAL REPORT OF GOVERNMENTAL ENTITIES As pointed out in Chapter 17 (page 714), the Governmental Accounting Standards Board s issuance in 1999 of GASB Statement No. 34, created renewed interest in financial reporting by state and local governmental entities. The GASB reported its objective in issuing GASB Statement No. 34, as follows: 7 Ibid., Sec. I

16 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 795 The Board s objective with this Statement is to establish a basic financial reporting model that will result in greater accountability by state and local governments by providing more useful information to a wider range of users than did the previous model. The new model also improves on earlier standards and proposals for modifying the previous model, GASB Statement No. 33 A Preliminary Step Before issuing GASB Statement No. 34, the GASB resolved the pressing issue of accounting for a governmental entity s nonexchange transactions, such as most taxes, grants, and private donations. The four classes of nonexchange transactions and their recognitions established by the GASB are summarized in the following chart: 9 Classes and Timing of Recognition of Nonexchange Transactions Class Derived tax revenues Examples: sales taxes, personal and corporate income taxes, motor fuel taxes, and similar taxes on earnings or consumption Imposed nonexchange revenues Examples: property taxes, most fines and forfeitures Government-mandated nonexchange transactions Examples: federal government mandates on state and local governments Voluntary nonexchange transactions Examples: certain grants and entitlements, most donations Recognition Assets* Period when underlying exchange has occurred or when resources are received, whichever is first. Revenues Period when underlying exchange has occurred. (Report advance receipts as deferred revenues.) When modified accrual accounting is used, resources also should be available. Assets* Period when an enforceable legal claim has arisen or when resources are received, whichever is first. Revenues Period when resources are required to be used or first period that use is permitted (for example, for property taxes, the period for which levied). When modified accrual accounting is used, resources also should be available. (For property taxes, apply NCGA Interpretation 3, as amended.) Assets* and liabilities Period when all eligibility requirements have been met or (for asset recognition) when resources are received, whichever is first. Revenues and expenses or expenditures Period when all eligibility requirements have have been met. Report advance receipts or payments for use in the following period as deferred revenues or advances, respectively. However, when a provider precludes the sale, disbursement, or consumption or resources for a specified number of years, until a specified event has occurred, or permanently [for example, permanent and term endowments], report revenues and expenses or expenditures when the resources are, respectively, received or paid and report resulting net assets, equity, of fund balance as restricted. When modified accrual accounting is used for revenue recognition, resources also should be available. *If there are purpose restrictions, report restricted net assets (or equity or fund balance) or, for governmental funds, a reservation of fund balance. 8 GASB Statement No. 34, par Codification, Sec. N

17 796 Part Five Accounting for Subsequent to its issuance, GASB Statement No. 33 was modified with respect to accounting for a governmental entity s derived tax revenues or imposed nonexchange revenues shared with other governmental entities. 10 Subsequent Steps GASB Statements No. 35, 37, 38, and 41 Subsequent to the issuance of GASB Statement No. 34, the GASB issued four additional statements that either modified or supplemented Statement No. 34, as follows: 1. GASB Statement No. 35, Basic Financial Statements and Management s Discussion and Analysis for Public Colleges and Universities. This statement merely amended Statement No. 34 to include public colleges and universities within its scope GASB Statement No. 37, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments: Omnibus. This statement s purpose was to encourage financial managers of governmental entities to report management discussion and analysis items that have the most relevance and to avoid boilerplate language GASB Statement No. 38, Certain Financial Statement Note Disclosures. Following a general disclosure principle that disclosure in the notes to the financial statements of a governmental entity is needed only when the information required to be disclosed is not displayed on the face of the financial statements, GASB Statement No. 38 established and modified disclosure requirements related to the following: Summary of significant accounting policies Violations of finance-related legal or contractual provisions Debt and lease obligations Short-term debt Disaggregation of receivable and payable balances Interfund balances and transfers GASB Statement No. 41, Budgetary Comparison Schedules Perspective Differences. This statement requires a governmental entity that, because of perspective differences, is unable to present budgetary comparisons for the general fund and major special revenue funds to present, as required supplementary information, budgetary comparison schedules based on the fund, organization, or program structure that the entity uses for its legally adopted budget. 14 Composition of a Governmental Entity s Comprehensive Annual Financial Report The Governmental Accounting Standards Board provided the following general guidelines for a governmental entity s comprehensive annual financial report: a. A comprehensive annual financial report should be prepared and published, covering all activities of the primary government (including its blended component units*) and providing an overview of all discretely presented component units* of the reporting entity 10 Codification, Sec. N Ibid., Sec. Co Ibid., Sec Ibid., Secs , , Ibid., Sec * The term component units is defined on page 717 of Chapter 17.

18 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 797 including introductory section, management s discussion and analysis (MD&A), basic financial statements, required supplementary information other than MD&A, appropriate combining and individual fund statements, schedules, narrative explanations, and statistical section. The reporting entity is the primary government (including its blended component units) and all discretely presented component units.... b. The minimum requirements for MD&A, basic financial statements, and required supplementary information other than MD&A are: (1) Management s discussion and analysis. (2) Basic financial statements. The basic financial statements should include: (a) Government-wide financial statements. (b) Fund financial statements. (c) Notes to the financial statements. (3) Required supplementary information other than MD&A. 15 The GASB diagrammed the foregoing features of a comprehensive annual financial report as follows: 16 Management s discussion and analysis Government-wide financial statements Fund financial statements Notes to the financial statements Required supplementary information (other than MD&A) The GASB provided general guidance for the sections of a comprehensive annual financial report as follows: 1. Management s Discussion and Analysis should discuss the current-year results in comparison with the prior year, with emphasis on the current year. This fact-based analysis should discuss the positive and negative aspects of the comparison with the prior year Ibid., Sec Statement of Principle, b and c. 16 Ibid., Sec Ibid., Sec

19 798 Part Five Accounting for 2. The government-wide financial statements consist of a statement of net assets and a statement of activities. Those statements should: a. Report information about the overall government without displaying individual funds or fund types b. Exclude information about fiduciary activities, including component units that are fiduciary in nature (such as certain public employee retirement systems) c. Distinguish between the primary government and its discretely presented component units d. Distinguish between governmental activities and business-type activities of the primary government e. Measure and report all assets (both financial and capital), liabilities, revenues, expenses, gains, and losses using the...accrual basis of accounting Separate financial statements should be presented for the primary government s governmental and proprietary funds The notes to the financial statements should communicate information essential for fair presentation of the financial statements that is not displayed on the face of the financial statements. As such, the notes are an integral part of the basic financial statements. The notes should focus on the primary government specifically, its governmental activities, business-type activities, major funds, and nonmajor funds in the aggregate Required supplementary information consists of schedules, statistical data, and other information that the GASB has determined are an essential part of financial reporting and should be presented with, but are not part of, the basic financial statements of a governmental entity. 21 The foregoing discussion regarding the comprehensive annual financial report of a governmental entity suggests that such a report may be a complex, voluminous disclosure instrument. The statement of net assets and the statement of activities of the City of Alexandria, Virginia, for the fiscal year ended June 30, 2000, are clear evidence of such complexity. 22 SEC ENFORCEMENT ACTION DEALING WITH WRONGFUL APPLICATION OF ACCOUNTING AND REPORTING STANDARDS FOR GOVERNMENTAL ENTITY AAER 970 In AAER 970, In the Matter of The City of Syracuse, New York, Warren D. Simpson, and Edward D. Polgreen (September 30, 1997), the SEC reported that official statements produced by the City of Syracuse in connection with the issuance of $23,000,000 face amount of one-year bond anticipation notes were materially false and misleading. According to the SEC, the combined statements of revenue, expenditures, and changes in fund balances for the City s general and debt service funds reported a $400,000 excess of revenues over 18 Ibid., Sec Ibid., Sec Ibid., Sec Ibid., Sec Bruce W. Chase and Laura B. Iriggs, How to Implement GASB Statement No. 34, Journal of Accountancy, November 2001 (Jersey City: American Institute of Certified Public Accountants, Inc.), pp

20 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR 799 expenditures instead of the actual $9,400,000 excess of expenditures over revenues. In addition, the combined ending fund balances of the general and debt service funds were overstated by $24,200,000. According to the SEC, the primary cause of the misstatements was the preparation of the combined financial statements before the City s accounting records had been closed for the relevant fiscal year and the premature recognition of property tax revenues. The City, its most senior accountant in its Finance Department, and its First Deputy Commissioner of Finance agreed to cease and desist from violating the Securities Act of 1933 and the Securities and Exchange Act of Review Questions 1. Under what circumstances are general obligation bonds payable of a governmental entity recorded in the governmental entity s enterprise fund? Explain. 2. The accounting for a governmental entity s enterprise fund in many respects is similar to the accounting for a business enterprise; yet there are a number of differences between the two types of accounting. Identify at least three of the differences. 3. Why does a governmental entity s enterprise fund have restricted assets in its statement of net assets? Explain. 4. What are the four categories of cash flows in the statement of cash flows for a governmental entity s enterprise fund? 5. How is the excess of total assets over total liabilities displayed in the financial statements of a governmental entity s internal service fund? Explain. 6. How does the statement of net assets of a governmental entity s internal service fund differ from the statement of net assets of the governmental entity s enterprise fund? Explain. 7. Is a statement of revenues, expenses, and changes in fiduciary net assets issued for an agency fund of a governmental entity? Explain. 8. Accounting for a nonexpendable trust for which a governmental entity acts as custodian requires the establishment of two separate private-purpose trust funds. Why is this true? 9. Explain the nature of the contributions in the statement of changes in fiduciary net assets of a governmental entity s pension trust fund. 10. Are fund financial statements the only financial statements included in the comprehensive annual financial report of a governmental entity? Explain. 11. Does the management s discussion and analysis section of a governmental entity s comprehensive annual financial report include required supplementary financial information? Explain. Exercises (Exercise 19.1) Select the best answer for each of the following multiple-choice questions: 1. An agency fund of a governmental entity is an example of which of the following type of fund? a. Fiduciary b. Governmental c. Proprietary d. Internal service

21 800 Part Five Accounting for 2. Is a Contributed Capital from General Fund amount displayed in the statement of net assets of a governmental entity s: Enterprise Fund? Internal Service Fund? a. Yes No b. No Yes c. No No d. Yes Yes 3. The following transactions were among those reported by the Scobey County Water and Power Enterprise Fund for the fiscal year ended June 30, 2006: Proceeds from issuance of revenue bonds $5,000,000 Cash deposits received from customer households 3,000,000 Cash contributed by subdividers 1,000,000 In the water and power enterprise fund s statement of cash flows for the year ended June 30, 2006, the amount to be reported as cash flows from capital and related financing activities is: a. $9,000,000 b. $8,000,000 c. $6,000,000 d. $5,000, Does a governmental entity s agency fund issue a: Statement of Fiduciary Statement of Changes Assets in Fiduciary Net Assets? a. Yes Yes b. Yes No c. No Yes d. No No 5. Slade City Internal Service Fund received a transfer in of $50,000 cash from the General Fund. This $50,000 transfer is accounted for in the Internal Service Fund with a credit to: a. Revenues. b. Other Financing Sources. c. Accounts Payable. d. Transfers In 6. Is the entire fund balance reserved in: A Nonexpendable An Expendable Private-Purpose Trust Fund? Private-Purpose Trust Fund? a. Yes Yes b. Yes No c. No Yes d. No No

22 Chapter 19 Governmental Entities: Proprietary and Fiduciary Funds, CAFR Which of the following funds of a governmental entity uses the same basis of accounting as an enterprise fund? a. Special revenue funds. b. Internal service funds. c. Permanent funds. d. Capital projects funds. 8. Restricted assets are displayed in a governmental entity statement of net assets for: a. Both an enterprise fund and an internal service fund. b. Neither an enterprise fund nor an internal service fund. c. An enterprise fund only. d. An internal service fund only. 9. Which of the following funds of a governmental entity may account for expendable or nonexpendable resources? a. Debt service funds. b. Enterprise funds. c. Private-purpose trust funds. d. Special revenue funds. e. None of the foregoing funds. 10. Customers deposits that may not be spent for operating purposes are displayed in the statement of net assets of the enterprise fund of a governmental entity as: a. Restricted cash or investments. b. Nonrestricted cash or investments. c. Payable to general fund. d. Payable to special revenue fund. 11. Does an agency fund for a governmental entity issue: A Statement of A Statement of Changes A Statement of Fiduciary Assets in Fiduciary Net Assets Cash Flows? a. Yes Yes Yes b. Yes No Yes c. Yes Yes No d. Yes No No (Exercise 19.2) 12. A Net Assets Reserved for Endowment ledger account is appropriate for: a. An endowment principal nonexpendable trust fund only. b. An endowment revenues expendable trust fund only. c. Either an endowment principal nonexpendable trust fund or an endowment revenues expendable trust fund. d. Neither an endowment principal nonexpendable trust fund nor an endowment revenues expendable trust fund. 13. Which of the following taxes is not a tax revenue of a governmental entity that is classified as derived under GASB Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions? a. Sales tax b. Personal income tax c. Motor fuel tax d. Property tax The Enterprise Fund of Orchard City billed the Orchard City General Fund $16,400 for utility services on May 31, Prepare journal entries for the May 31, 2006, billing for both the Orchard City General Fund and the Orchard City Enterprise Fund.