Fund Accounting

Internal fiscal control for governmental activities is carried out through fund accounting. Funds are established within public organizations for the purposes of maintaining accounting records and preparing financial statements. The National Council on Governmental Accounting (NCGA) has defined a fund as:

a fiscal and accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equities or balances, and changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions or limitations. [4]

Major Funds

Many local governments manage and account for their financial activities in a limited number of funds--designated as major funds. The Governmental Accounting Standards Board (GASB) has recommended [5]:

(1) The main operating fund (the general fund or its equivalent) should always be reported separately.

(2) Other governmental funds and proprietary funds be reported as major funds if the total assets, liabilities, revenues. or expenditures/ expenses of that individual fund are at least 10 percent of the corresponding total (assets, liabilities, and so forth) for the relevant fund category (governmental fund or proprietary funds) and at least 5 percent of the corresponding total for all governmental and proprietary funds combined.

(3) Any other funds that public official believe are particularly important to financial statement users (for example, because of public interest or consistency) be reported as major funds. The sources and uses of financial resources and the balances remaining in the non-major funds are reported in the aggregate. Combining statements for these non-major funds are not required, but if presented, should be included as supplementary information.

Accounting and budgetary requirements tend to vary widely among these funds. These requirements can be summarized, however, by considering four general groupings of funds.

Current operations involve appropriated or allocated moneys that currently are expendable from general funds, special revenue funds, debt service funds, and certain expendable trust funds. Fixed assets and long-term liabilities are excluded from the balance sheets of these funds. These funds often are accounted for on a modified accrual or encumbrance basis in order to record liabilities (expenditures) as they are incurred. However, most types of revenue are not recorded in these funds until they are received in cash. This approach results in a rather conservative state-ment of the balance of funds currently available for approved activities.

Capital project and debt service funds and special assessment funds are concerned with capital spending. The ordinances that create these funds normally include specific budget restrictions regarding the conditions under which such funds can be expended. As a consequence, these funds typically are not included in the annual appropriation ordinance. The GASB proposed new definitions of capital projects and debt service funds in the 1997 Exposure Draft. However, the concern arose that new definitions may cause some governments to change their fund reporting practices, and as a consequence, the Board agreed to adopt definitions in the final standard that are derived from all current GAAP requirements. For example, the new definition of capital project funds will be based on guidance provided in NCGA Statements 1 and 2.

Commercial-type funds record activities that are expected to earn a profit, or at least recover costs. This category includes proprietary or enterprise funds, internal service funds, and trust funds concerned with invested principal that earns an income. These funds have complete balance sheets that include both fixed assets and long-term liabilities. Revenue and expenditures are recorded on an accrual basis. Budgets for these funds usually serve as guidelines for operations, rather than as legal limits on expenditures.

Custodial funds are self-balancing liability accounts that record assets held for other entities. In some states, for example, certain fines collected by municipal courts are paid over to the school district. A custodial fund would account for these fines during the interval between collection and their transfer to the school district. Budgetary controls are unnecessary for such funds.

Two self-balancing groups of accounts constitute a second major component of governmental accounting. These accounts are not funds because they do not contain resources that can be appropriated. They are "holding areas" that accomplish three important purposes: (1) to segregate fixed assets and long-term liabilities from each other, thereby avoiding meaningless data on capital surplus; (2) to permit most funds to be operated on the basis of current assets and liabilities only; and (3) to bring together related accounts in one accounting compartment for control purposes.

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 long-term liabilities assumed by the unit involving the commitment of governmental funds (except those associated with special assessment funds). The use of these nonfund accounts can be illustrated by tracing the transactions that occur when a general obligation bond is issued and subsequently matures.

The bond is recorded initially as part of the general long-term debt account where it represents an obligation that must be paid at some time in the future. The revenue generated by the issuance of the bond is recorded in an appropriate capital project fund. When the project funded by the bond issue is completed, the facility is recorded as a capital asset in the general fixed assets account. When the bond reaches maturity, the liability (in terms of a principal payment) becomes a current obligation of a debt service fund. Therefore, it is removed from long-term debt account, and the total long-term debt is reduced accordingly. Should the capital facility (asset) subsequently be sold, the revenues would be recorded in the general fund, and the total general fixed assets of the government entity would be reduced accordingly.

In fund accounting, revenues are controlled through an appropriation process, and proposed expenditures are controlled through a line-item budget. Expenditures from any line item--such as salaries, supplies and materials, travel, contractual services, or equipment--cannot exceed the dollar amount that has been appropriated or allocated to that particular line item.

Both revenue and expenditures can be cross-referenced through basic accounting classifications (or charts of accounts). Revenue is classified by fund and by source, and sometimes by collecting agency. Expenditure classifications are more elaborate, often providing details by fund, organizational unit, function, program, activity, character, and object. Standard accounting classifications, promulgated by the NCGA, have helped bring about a degree of uniformity among state and local governments in the use of terminology and in account titles.

Fund accounting has built-in controls through the use of budgetary transactions along with actual financial transactions. The accounting system tracks expenditures categories (line-items or object codes) and will show when any category is about to exceed the amount appropriated or allocated for that purpose. When an order is placed for goods or services, for example, a legal commitment is made. By encumbering the funds necessary to meet that commitment, the organizational unit will be assured that the allocation will not be over-spent when the time comes to pay for the goods or services. Otherwise, funds may not be available to pay for the ordered goods when they arrive, along with an invoice.

Most of the information needed to control expenditures--by depart-ment, function, or line-items/objects--is maintained in subsidiary ledgers. Other functional categories or departments and other line-items and/or objects of expenditure could be added to this subsidiary ledger.

Personal services include not only salaries and wages but also such employee benefits as the city's share of retirement contributions, FICA payments, and hospitalization insurance. In addition, the city withholds state and federal taxes. As a rule, agency funds are established to account for withholding and retirement contributions for all funds, rather than accounting for these items separately in each fund.

Salaries and wages usually are not encumbered, because the amounts are fairly constant for the payroll periods as well as for the year. If the city budget reflects salaries and wages for the entire year, rather than for a fiscal year ending on pay periods, then an amount for salaries owed can be accrued at the end of the year.

Detailed information on the amount of withholding for individual employees should be kept in a subsidiary ledger in the agency fund, so that W-2 forms can be prepared at the end of the year. Information concerning pensions and retirement for each employee must also be drawn from these subsidiary ledgers.

Materials and supplies can be tracked in one of three ways: (1) as a perpetual inventory, shown as expenditures when consumed; (2) as an expenditure when purchased, with physical inventory taken at the end of the year to determine the amount remaining in the inventory account; or (3) as an expenditure when purchased, with no inventory account shown. Often a central purchasing agency (e.g., central stores) is established in public organizations to maintain detailed inventory accounts, allowing operating agencies to treat the acquisition of materials and supplies as an expenditures at the time the transaction occurs.

The accounting for contractual services (services purchased outside the organizational unit, including telephone services, maintenance agreements on equipment, insurance, and the like) and travel (sometimes included under contractual services) is fairly straightforward. Funds for such services may be encumbered when the purchase order is issued or the contract is let. Alternatively, these expenses may be recorded on an "as billed" basis, that is, when the actual invoice is received and paid.

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Equipment funds are usually encumbered when the purchase order is issued. The equipment category may be broadened to include all expenditures and encumbrances for fixed assets that have a relatively long life and cost more than a certain dollar amount (i.e., capital outlays). Such items as machinery, capital expansion or renovations of existing facilities, improvements and repairs of a capital nature, and land acquisitions may be included in this category.

Most of the money used for debt servicing--to pay off principal and interest on long-term debt--is transferred from the general fund to the debt service fund. Long-term liabilities and interest are then paid from this fund. Usually, the debt service fund is included in the budget and appropriation of only one department (for examples., general government). The amounts to be paid are usually known, so there is seldom any reason to accrue or encumber any of the funds.

As shown in Exhibits 6 and 7, subsidiary expenditure ledgers can be summarized by function or organizational unit. As these data show, expenditures in support of education are over budget in every line-item except equipment. Public safety also shows a negative balance overall as a consequence of the overcommitment for personal services. The other functional categories show positive balances, and as a result, the budget as a whole shows a positive balance, as summarized in Exhibit 8.

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