GOVERNMENTAL AND NONPROFIT ACCOUNTING

GOVERNMENTAL AND NONPROFIT ACCOUNTING Theory and Practice TENTH EDITION Robert J. Freeman Texas Tech University Craig D. Shoulders Western Carolina University Gregory S. Allison University of North Carolina Chapel Hill G. Robert Smith, Jr. Middle Tennessee State University PEARSON Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

Contents Preface xxi CHAPTER 1 Governmental and Nonprofit Accounting: Environment and Characteristics 1 Characteristics and Types of G&NP Organizations 2 G&NP Sector Significance 2 The G&NP Environment 3 Objectives of G&NP Accounting and Financial Reporting 6 Authoritative Sources of G&NP Accounting Principles and Reporting Standards 6 TheFAF 7 TheFASB 7 FASB-GASB Jurisdictions 7 "Government" Defined 7 TheGASB 9 GAAP Hierarchies 11 Concepts and Objectives of SLG Accounting and Financial Reporting 12 Governmental-Type Activities 13 Financial Report Users 17 Financial Report Uses 18 Business-Type Activities 18 Users and Uses of Financial Reports 19 Financial Reporting Objectives 20 Characteristics of SLG Accounting and Financial Reporting 21 Fund Accounting 21 Budgets and Appropriations 22 Other Distinguishing Characteristics 23 Commercial Accounting Comparison 24 Concluding Comments 24 APPENDIX 1-1 Evolution of Accounting Principles and Standards Prior to the GASB 25 Questions 28 Exercises 28 Problems 30. ] CHAPTER 2 State and Local Government Accounting and Financial Reporting Model: The Foundation 31 Overview of the GASB Financial Reporting Model 32 The Fundamental Features of the SLG Accounting and Financial Reporting Model 33 GAAP and Legal Compliance 35 Fund Accounting 36 Fund Categories 37 Transaction Analysis 42 Types of Funds 45 Comparative Financial Statement Formats 50 Annual Financial Reporting 55 IX

X Contents Concluding Comments 58 Questions 59 Exercises 60 \ Problems 64 Cases 67 CHAPTER 3 The General Fund and Special Revenue Funds 69 Measurement Focus 70 Purposes and Assumptions of This Chapter 71 r General Fund Accounting Illustrative Example 71 Entries During 20X1 71 Year-End Adjustments 83 Preclosing Trial Balances 84 Illustrative Example Worksheets 84 20X1 Closing Entries 84 Postclosing Trial Balance 86 Balance Sheets 87 Interim Balance Sheet 87 Year-End Balance Sheet 87 Fund Balance 88 Fund Balance Reporting Classifications 89 Interfund Receivables and Payables 92 Capital Assets and Long-Term Liabilities 92 Statement of Revenues, Expenditures, and Changes in Fund Balances 93 Restatements 94 Extraordinary Items and Special Items 95 Classification of Expenditures 95 Combining Special Revenue. Fund Statements 98 Concluding Comments 100 APPENDIX 3-1 General Ledger Worksheet and Subsidiary Ledgers 100 APPENDIX 3-2 Classification of Expenditures 100 APPENDIX 3-3 Alternative Account Structure and Entries 109 Questions 110 Exercises 110 Problems 115 Cases 119 CHAPTER 4 Budgeting, Budgetary Accounting, and Budgetary Reporting 121 The Government Budgetary Perspective 122 Budgetary Accounting and Reporting 123 Budgetary Accounting and Control 123 Recording the Budget General Ledger and Subsidiary Ledger 127 Budget Revisions 127 Revenues and Expenditures Ledgers Incorporating Budgetary Accounts 132 Level of Detail in Subsidiary Ledgers' 137 Budgetary Reporting Overview 137 The Budgetary Basis 138 Interim Budgetary Statements 138

Contents XI Budget Comparison Schedule or Statement of Revenues, Expenditures, and Changes in Fund Balance Budget and Actual 140 Budgetary Comparison Statement Illustrated Budgetary Basis'-.Same as GAAP 141 Budgetary Comparison Statement Illustrated Budgetary Basis Differsirom GAAP 143 Entries during 20X2 145 Budgetary Planning, Control, and Evaluation 146 Planning 146 Control 146 Evaluation 147 Basic Budgetary Terminology 147 t Capital vs. Current Budgets 147 Tentative vs. Enacted Budgets 148 General vs. Special Budgets 149 Fixed vs. Flexible Budgets 150 Executive vs. Legislative Budgets 150 Budgetary Approaches and Emphases 150 Budget Preparation 151 Overview 151 Preliminary Estimates 151 Preparing the Budget 152 Revenue Estimates and Requests 153 Expenditure Estimates and Requests 153 Expenditure Budgeting Approaches 153 Legislative Consideration and Action 155 Budget Execution 156 Concluding Comments 157 Questions 157 Exercises 158 Problems 162 Cases 166 Harvey City Comprehensive Case 169 CHAPTER 5 Revenue Accounting Governmental Funds 174 Revenue Definition and Recognition 175 Nonexchange Transactions 177 Governmental Fund and Proprietary Fund Revenue Recognition Compared 179 Classification of Revenue Accounts 181 General Fund Revenues 181 Other Governmental Funds Revenues 181 Taxes 182 Taxpayer-Assessed Taxes 182 Property Taxes 183 Property Tax Statements/Schedules 192 Licenses and Permits 192 Intergovernmental Revenues 193 Intergovernmental Revenue Classifications 193 Intergovernmental Revenue Accounting 194 Charges for Services 197 Interfund Services vs. Reimbursements 197 Charges for Services 197 :

XII Contents Fines and Forfeits 199 Investment Earnings 200 Miscellaneous Revenues 203 Escheats 203 Private Contributions 204 Selected Nonrevenue Fund Balance Increases 204 Capital Asset Sales/Losses 204 Internal PILOTs 204 Collateralized Borrowings 205 Revenue Reporting: GAAP vs. Budgetary 205 ' Balance Sheet Reporting Related to Unrecognized Revenues 205 Changes in Accounting Principles 208 Error Corrections 209 Concluding Comments 209 Questions 210 Exercises 210 Problems 214 Cases 218 Harvey City Comprehensive Case 220 CHAPTER 6 Expenditure Accounting Governmental Funds 222 Expenditure Definition and Recognition 223 Capital Outlay Expenditures 224 Debt Service Expenditures 225 Intergovernmental Expenditures 225/ Current Operating Expenditures 225 Inventories and Prepayments 225 Expenditure Recognition Summary 226 Expenditure Accounting Controls 227 Expenditure Accounting Procedures 227 Personal Services 228 Materials and Supplies 230 Other Services and Charges 232 Adjusting Entries 235 Encumbrances 237 Debt Service 238 Claims and Judgments 238 Compensated Absences 242 Pension/OPEB Plan Contributions 243 Expenditure Reporting: GAAP vs. Budgetary 244 Changes in Accounting Principles 247 Alternative Principles 247 New GASB Standards 248 Error Correction 249 Concluding Comments 249 Questions 250 Exercises 250 Problems 252 Cases 258 Harvey City Comprehensive Case 260

Contents XIII CHAPTER 7 Capital Projects Funds 262 Capital Projects Fund Operations and Accounting Standards 264 CPF Financial Resources 264 Number of Funds 264 CPF Life Cycle 265 The Budget 266 Interim Financing 267 Project Costs 268 Intergovernmental Revenues 269 Recording Bond Issues 269 Capital Projects Fund Case Illustration Begun, 20X1 269 Budgetary Entry 270 Transaction/Event Entries 271 General Ledger Worksheet(s) 272 Preclosing Trial Balance 274 Closing Entries 274 Financial Statements 275 Capital Projects Fund Case Illustration Concluded, 20X2 278 20X1 Accounts Closed 278 Case Illustration Assumptions and Entries 20X2 278 General Ledger Worksheet 280 20X2 Financial Statements 281 Other Capital Projects Fund Operations, Accounting, and Reporting Matters 284 Bond Anticipation Notes (BANs) 284 Investments and Arbitrage 285 Remaining Fund Balance 285 Reporting Multiple Projects 286 - Combining CPF Statements 286 Concluding Comments 287 Questions 287 Exercises 287 Problems 291 Cases 297 Harvey City Comprehensive Case 299 CHAPTER 8 Debt Service Funds 301 Debt Service Fund Environment, Financing, and Expenditure Recognition 302 Long-Term Liabilities 302 Fixed vs. Variable Rates 303 Debt Service Payments 304 Bonds and Fiscal Agents 304 Required DSF Reserves 305 Bond Ratings 305 Bond Insurance 305 Sources of Financing 306, DSF Investments 306 DSF Expenditure Recognition 306 Debt Service Fund for a Serial Bond Issue: Case Illustration 307 Illustrative Entries 308 Financial Statements 310

XIV Contents Special Assessment Debt Service Funds 311 Illustrative Entries 312 Illustrative Financial Statements 314 '! Other Conventional Debt Service Fund Considerations 315 Nonaccrual of Interest 315 Combining Balance Sheet 315 Combining Operating Statement 316 Debt Service Fund for a Term Bond Issue 316 Sinking Fund Requirements 318 Debt Service Funds for Deep Discount Issues 319 ' Refundings 320 Reasons for Refund ings 320 Refundings Defined 320 Defeasance of Debt 321 Debt Service Funds for Refundings 323 Current Refunding 324 Advance Refunding' 325 Debt and Nondebt Financing 326 Reporting Refundings 327 f Advance Refunding Disclosures 327 Concluding Comments 330 Questions 331 Exercises 332 Problems 335 Cases 340 Harvey City Comprehensive Case 341 CHAPTER 9 General Capital Assets; General Long-Term Liabilities; Permanent Funds: Introduction to Interfund-GCA-GLTL Accounting 343 Overview of General Capital Assets and General Long-Term Liabilities Accounting Procedures 344 General Capital Assets 345 General Capital Assets Defined 345 Initial Valuation 346 Classification 347 ' Capitalization Policy 347 Property Records 349 Capital Assets Inventory 350 Additions, Betterments, and Renewals 350 Depreciation/Accumulated Depreciation 351 Updating GCA Accounts 352 Recording Depreciation 356 Sale, Replacement, or Retirement 356 Intragovernmental Transactions 357 Impairment 359 Insurance Recoveries 361 Damage or Destruction 362 Reporting and Disclosures 363 General Long-Term Liabilities 363 CPF-DSF-GLTL 366 Serial Debt 366

Contents XV Special Assessment Debt 367 Other Government Liabilities 367 Interest-Related Adjustments 368 Defaulted Bonds 369 In-Substance Defeasance 369 GLTL Records 369 GLTL Reporting and Disclosures 370 Permanent Funds 370 Introduction to Interfund-GCA-GLTL Accounting 373 Concluding Comments 3 7 8 Questions 378 Exercises 379 Problems 383 Cases 387 Harvey City Comprehensive Case 3 8 9 CHAPTER 10 Enterprise Funds 392 c Common Characteristics and Principles of Proprietary Funds 392 Accounting Equation 392 Accounting Principles 393 Financial Statements 393 Enterprise Funds Defined 394 EF Accounting Illustrated 395 Budgeting and Appropriations 396 Interfund Activity * 396 ' Intergovernmental Grants 396 Interest Capitalization 397 Establishment of Fund and Acquisition of Plant 397 Accounting for Routine Operating Transactions 398 Preclosing Trial Balance and Financial Statements Basic Example 401 EF Accounting Extended Illustration 410 Enterprise Fund Reporting Extended Example 420 Combining Enterprise Fund Financial Statements 425 Concluding Comments 429 ' Questions 429 Exercises 430 Problems 433 Cases 438 Harvey City Comprehensive Case 441 CHAPTER 11 Internal Service Funds 443 Overview of Accounting Principles 444 Initial Establishment 444 Pricing Policies 446 Pricing Methods 447 Relation to Budget 448 Financial Statements 448

XVI Contents Internal Service Fund Accounting Illustrated 448 Automotive Equipment Unit 448 Central Stores Fund 452 \ Self-Insurance Fund 456 Disposition of Increase or Decrease in Net Position 461 Dissolution of an Internal Service Fund 461 Combining Internal Service Fund Financial Statements 462 Concluding Comments 465 Questions 465 Exercises 466 Problems 468 Cases 471 Harvey City Comprehensive Case 472 CHAPTER 12 Trust and Agency (Fiduciary) Funds: Summary of Interfund-GCA-GLTL Accounting 474 The Accountability Focus 475 Agency Funds 476 Simpler Agency Funds 477 Tax Agency Funds 477 Special Assessment Agency Funds 482 Trust Funds 483 Private-Purpose Trusts 483 Investment Trusts 485 Pension Trusts 486 Combining Trust and Agency Fund Financial Statements 494 Additional Interfund-General Capital Asset-General Long-Term Liability Accounting Illustrations 495 Concluding Comments 500 Questions 501 Exercises 501 Problems 504 Cases 507 Harvey City Comprehensive Case 509 CHAPTER 13 Financial Reporting: The Basic Financial Statements and Required Supplementary Information 510 Basic Financial Statements Overview 512 Fund Financial Statements 513 Major Fund Reporting 513 Fund-Based Financial Statements 523 Government-Wide Financial Statements 526 Statement of Net Position 528 Statement of Activities 529 Measurement Focus 532 Reporting Expenses 533 Program vs. General Revenues 533 Internal Service Funds 536 Infrastructure Capital Assets 537 Note Disclosures 537

Contents XVII Required Supplementary Information 539 Management's Discussion and Analysis 539 Other RSI 539 Special Purpose Governments 539 Concluding Comments 541 Questions 541 Exercises 541 Problems 544 Cases 547 Harvey City Comprehensive Case 550 CHAPTER 14 Financial Reporting: Deriving Government-Wide Financial Statements and Required Reconciliations 551 Deriving Governmental Activities Data 553 Deriving Government-Wide Financial Statement Data for Governmental Activities A Worksheet-Based Approach 554 The Conversion Worksheets 554 Balance Sheet Conversion Worksheet Adjustments 559 Farley County Balance Sheet Conversion 562 Operating Statement Conversion Worksheet Adjustments 564 Farley County Operating Statement Conversion 567 Deriving Business-Type Activities Data 570 Statement of Net Position 572 Statement of Activities 572 Reconciliations 575 Concluding Comments 577 APPENDIX 14-1 A One-Worksheet Approach to Deriving Governmental Activities Data 577 Questions 587 Exercises 588 Problems 591 Cases 598 Harvey City Comprehensive Case 602 CHAPTER 15 Financial Reporting: The Comprehensive Annual Financial Report y and the Financial Reporting Entity 603 The Comprehensive Annual Financial Report 604 The Introductory Section 604 The Financial Section 606 The Statistical Section 610 Supplemental and Special Purpose Reporting 614 Financial Reporting Complex Entity Structure 614 Reporting Entity Definition 614 Reporting Entity Disclosures 617 Integrating Component Units into the Reporting Entity 617 Blending 621 Discrete Presentation 621 Dual Reporting Entity Model 623 Other Issues 623 Separate Issuance of Primary Government Financial Statements 624 Related Organizations, Joint Ventures, and Jointly Governed Organizations 624 Concluding Comments 625

XVIII Contents Questions 627 Exercises 628 Problems 631 \ Cases 634 Harvey City Comprehensive Case 636 CHAPTER 16 Non-SLG Not-for-Profit Organizations 637 Classification of Organizations 639 Voluntary Health and Welfare Organizations 639 Other Not-for-Profit Organizations 639 Classes of Net Assets 640 Non-GAAP Accounting and Reporting Requirements 641 Basis of Accounting 641 Financial Statements 641 Balance Sheet 64.1 Statement of Activities 643 Statement of Cash Flows 650 Statement of Functional Expenses 650 Nongovernment VHWO and ONPO Accounting and Reporting Illustration 650 Transactions and Entries 650 Illustrative Financial Statements 658 Concluding Comments 664 Questions 665 Exercises 665 Problems 669 / CHAPTER 17 Accounting for Colleges and Universities 675 Classification as "Engaged Only in Business-Type Activities" 676 GAAP Reporting Requirements 677 Statement of Net Position 677 Operating Statement 679 Statement of Cash Flows 685 Case Illustration A Government University 685 i Other Resources 689 Annuity and Life Income Gifts 695 Annuity Gifts 695 Life Income Gifts 699 Colleges and Universities Engaged in Both Governmental and Business-Type Activities 700 Nongovernment Not-for-Profit University Reporting 700 Concluding Comments 704 Questions 704 Exercises 704 Problems 706 CHAPTER 18 Accounting for Health Care Organizations 713 Funds Government Hospitals 714 Basic Principles 715

Contents XIX Unique Measurement and Display Features 715 Distinguishing Primary Activities 715 Classes of Revenues 715 Gains 718 Donations 718 Expense Classification 718 Restricted Assets 719 Property, Plant, and Equipment 720 Illustrative Case 720 Summary of Transactions and Events 720 Financial Statements 729 Statement of Net Position 729 Operating Statement 729 Statement of Cash Flows 729 Nongovernment Not-for-Profit Hospital Reporting 729 Concluding Comments 736 Questions 736 Exercises 737 Problems 740 CHAPTER 19 Federal Government Accounting 743 The Federal Financial Management Environment 744 Financial Accounting Responsibilities 744 Overview 746 The Budgetary Process 747 The Budget Cycle 747 Exceeding Budget Authority 750 ' Accounting Principles and Standards for Federal Agencies 750 The Federal Model 750 Standard General Ledger 754 Federal Fund Structure 755 Financial Reporting 755 Federal Agency Accounting and Reporting Illustrated 759 A Case Illustration 759 Maintaining Budgetary Control 759 Maintaining Proprietary Accounts 764 Other Transactions and Entries 764 Closing Entries 768 Reporting 770 Concluding Comments 775 Questions 775 Exercises 775 Problems 777 CHAPTER 20 Auditing Governments and Not-for-Profit Organizations 780 Overview 781 What Is an Audit? 781 Classifications of Audits 781 Management's Representations 783 External Auditor Classifications 783 Engagement Letter 784

XX Contents Auditing Standards 784 AICPA Auditing Standards 784 GAO Auditing Standards 786 "\ GAGAS 2011 Summary 787 The Financial Audit 789 1 Auditing Standards 789 Audit Procedures 789 The Audit Report 790 The Single Audit 792 Purposes 793 Applicability 793 Definitions 794 Objectives 794 Overview 794 Auditee Responsibilities 795 Auditor Responsibilities 795 Auditing Guidance 799 Major FFA Programs' 800 Findings & Questioned Costs 803 Illegal Acts 804 Subrecipients 805 Auditor Reports Single Audit 805 Auditee Reporting Responsibilities 808 Other Matters 809 Concluding Comments 809 APPENDIX 20-1 Glossary 809 APPENDIX 20-2 Data Collection Form for Reporting on Audits of States, Local Governments, and Nonprofit Organizations 811 Questions 815 Exercises 815 Problems 819 Cases 820 Index 823 n