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An effective accounting system provides quantitative information for three broad purposes:


Accounting serves as an information system through which fiscal data and events are recorded, classified, summarized, interpreted, and communicated for decision-making purposes.

Financial Accounting

Financial accounting is concerned with the results of fiscal transactions and the consequent fiscal position of an organizational entity.

A sound governmental accounting system must be built around four components:

A fund is an independent fiscal and accounting entity to which resources are assigned, together with all related liabilities, obligations, reserves, and equities.

Financial transactions are made between funds and are recorded in accounting ledgers according to a predetermined chart of accounts..

Financial Statements

Three important financial statements are:

Revenues represent an inflow of money and/or other representations of value in return for selling goods or providing some type of service.

Expenses represent outflows of resources, or the incurring of obligations, for goods and services required to generate revenues.

Net income is simply the excess of revenues over expenses.

Owner's equity, an important concept in commercial accounting, is sometimes called net worth, capital, or proprietorship.

Fund equity is substituted for owner's equity in governmental accounting and represents the residual in a fund after obligations have been deducted.

Equity is always equal to the assets minus the liabilities of an entity.

The Basic Accounting Equation

The basic accounting equation can be expressed as follows:

Profit-seeking entities seek to generate net income; not-for-profit organizations strive to "break even," that is, to balance revenues and expenses.

Debits (increases) must equal credits (decreases)--the effect on the accounting system is described in terms of double-entry mechanics.

Accounting transaction are recorded as journal entries.

A trial balance provides proof that the ledger is in balance, but it does not verify that transactions have been correctly recorded in the proper accounts.

Fund Accounting

Funds are established within public organizations for the purposes of maintaining accounting records, controlling government activities, and preparing financial statements.

The funds most commonly found in public organizations include:

Separate financial statements are prepared for each of the major funds, and combined statements of funds with similar purposes often are distributed.

Account Groups

General Fixed Assets Account Group records all fixed assets--long-term resources of the governmental unit--acquired through Governmental Funds.

Long-Term Debt Account Group records general, long-term liabilities assumed by the governmental unit involving the commitment of Governmental Funds (except those associated with Special Assessment Funds).

Budgetary Accounting

The line-item budget is the primary fiscal mechanism to control governmental activities.

The budget serves as both a mandate for and a limitation on public spending--actual expenditures should closely coincide with budgetary appropriations.

Appropriations may be subdivided in to allocations according to agencies, programs, and classes of expenditures.

A system of encumbrances records the placement of purchase orders or the letting of contracts as an obligation against the agency's allocation and are liquidated on an "as-billed" basis.

An allotment system further subdivides appropriations into time elements.

Budget classification systems provide the means for organizing and facilitating comparisons among data on revenues and expenditures.

Accounting Equation for Governmental Funds

The expanded accounting equation for governmental funds can be expressed follows:

The following debit and credit conditions apply when recording items in accounts:

Bases for Accounting

On the revenue side, two bases for accounting are possible: the cash basis and the accrued revenue basis.

On the commitment (outflow) side, four bases are used: cash, obligations, accrued expenditure, and accrued cost.

Under a strict cash basis, revenues are recorded only when they are actually received, and expenditures are recorded when payments are made (as a cash disbursement).

Under a strict accrual basis:

Under a modified accrual basis:

Under a modified cost basis, property taxes and other receivables are placed on the books for control purposes when they are levied, but not accounted for as revenue until actually collected.

Under an accrued cost basis, unspent funds are carried over to the next fiscal period, as are encumbered obligations.

Use of Subsidiary Ledgers

Accounts are kept in the subsidiary ledger for the particular budgeted revenue, appropriations, actual revenue, expenditures, and encumbrances accounts.

Records must be kept in much greater detail in the subsidiary ledgers for a breakdown of other classes of revenue and expenditures than those usually shown in the general ledger.

Budget Adjustments

The budget may need to be adjusted at various times during the fiscal year to reflect additional information concerning estimated revenues and appropriations.

It may become necessary to decrease the appropriation if revenues fall short of the initial estimates and the fund balance is insufficient to cover the amount appropriated.

Closing Entries

In many governmental accounting systems, accounts are closed out at the end of the fiscal year and appropriated funds revert to the general fund.

Closing entries may be made in one of two ways:


Financial accounting focuses on accurate and objective recording of fiscal transactions and the preparation of reports on the fiscal affair of an organization for external users.

Cost accounting involves the assembly and recording of the elements of expense incurred to attain a purpose, to carry out an activity, operation, or program, to complete a unit of work or project, or to do a specific job.

Basic Concepts of Cost

Cost can be defined as a release of value required to accomplish some goal, objective, or purpose.

Measurement of Costs

Absorption or full costing considers all the fixed and variable costs associated with the provision of the goods or services in question.

Direct costing considers only the variable or incremental costs of a particular operation.

Responsibility costing assigns to an operating unit only those costs that its managers can control or at least influence.

Job order costing is used by companies in which products are readily identifiable by individual units or batches.

Process costing is most often used in the mass production of like units, which usually pass in continuous fashion through a series of uniform production steps.

Unit costs often are determined by dividing the current budget allocation for a given activity by the number of performance units.

Average unit costs may be determined by dividing accumulated costs by the quantities produced during the period.

Cost Allocation

Cost allocation is necessary whenever the full cost of a service or product must be determined.

Variable costs can be measured and assigned to appropriate activities or programs that generate such expenses.

Variable costs usually increase in some predictable and measurable fashion as additional units of work are undertaken.

Direct fixed costs do not vary with the activities being measured, and therefore, the allocation of these costs to specific services or projects can be more problematic.

Direct fixed costs (such as rent) might be allocated on the basis of some arbitrary physical measure, such as the floor space occupied by various activities, or by assuming some level of operation, such as number of persons to be served.

Overhead often is divided into two categories.

Standard Costs and Variance Analysis

Standard costs relate the cost of production to predetermined indices of operational efficiency.

Optimal or desired (planned) unit costs and related workload measures may be established for each job or activity.

Workload measures usually focus on time-and-effort indices, such as number of persons served per hour, yards of dirt moved per day, or more generally, volume of activity per unit of time.

Unit costs can be estimated for each of the cost elements by adjusting trend data for expected changes during the next fiscal period.


Managerial accounting is involved in formulating fiscal estimates of future performance (the planning and budgeting processes) and in analyzing actual performance in relation to these estimates (program evaluation and performance auditing).

Managerial accounting focuses on four basic functions: (1) management planning, (2) cost determination, (3) cost control, and (4) performance evaluation.

Significant features of managerial accounting include:

Cost Approximation Methods

Cost approximation involves an attempt to find predictable relationships between a dependent variable (cost) and an independent variable (some relevant activity) so that costs can be estimated over time based on the behavior of the independent variable.

Cost approximations typically are based on three major assumptions:

The five most commonly applied methods for approximating costs include:

Responsibility Accounting and Performance Evaluation

Responsibility accounting attempts to report results so that: (1) significant variances from planned performance can be identified; (2) reasons for the variances can be determined; (3) responsibility can be fixed; and (4) timely action can be taken to correct problems.

Responsibility centers may take several forms:

Costs charged to responsibility centers should be separated between direct and indirect costs.

Direct expenses should be further broken down between those which are controllable and non-controllable at the responsibility center level.

A variance can is the difference between the amount budgeted for a particular activity (during a given period) and the actual cost of carrying out that activity and may be positive (under budget) or negative (over budget).

Management by exception--at each level in the organizational hierarchy, the manager's attention can be concentrated on the variance from the budget items deemed to be most important.

Responsibility accounting seeks to assign accountability to those individuals who have the greatest potential influence, on a day-to-day basis, over the costs in question.

A delicate balance must be maintained between the careful delineation of responsibility on the one hand and a too-rigid separation of responsibility on the other.

Responsibility Center Management

Responsibility Center Management combines principles and techniques of responsibility accounting and activity-based costing.

All sources of financial support (income/revenue) and all costs (direct and indirect) are attributed to responsibility centers on some consistent basis.

Costs associated with internal service centers (i.e., units that do not receive revenue or income from external sources) are charged to responsibility centers on a "fee for sevice basis" or are recovered through some form of assessment.

Activity-Based Costing provides a method for tracing costs from the traditional cost accounting structure to activities--which relates why resources are being consumed.

Responsibility Center Management may require the use of subvention--a central allocation to cover deficits between the income/revenue and the costs assigned to responsibility centers.


A multipurpose accounting system incorporates the advantages of the object-of-expenditure budget and accounting approach with the timely management information of cost-managerial accounting procedures.

Data Crosswalks

The term crosswalk refers to any data conversion that involves a change in budget and accounting classification systems (for example, from objects of expenditures to programs, or vice versa).

Program managers must have timely data on expenditures both by programs and by the agencies authorized to make such commitments.

Expenditures Versus Costs

To determine where the costs come from, it is necessary to know the amount of costs from each department or agency that goes into each program.


Fund accounting produces financial statements and reports that can be audited in accordance with generally accepted accounting principles.

Budgetary accounting permits comparisons between actual revenues and expenditures recorded during the fiscal year and revenues and expenditures appropriated in agency budgets.

The basic objective of cost and managerial accounting is the provision of information for improved fiscal management decisions.

An important step in controlling costs is to determine how they function under various conditions--to find predictable relationships between cost and one or more independent variables (organizational activities).

Responsibility accounting seeks to assign accountability to those sectors of an organization (cost centers and responsibility centers) in which day-to-day influence/control can be exercised over the costs in question.

A multipurpose accounting system facilitates the crosswalk of data between agencies and programs to provide important management information essential to an evaluation of the overall effectiveness of program activities.