Budgetary Accounting

It is important that the data presented in budget requests and reflected in appropriations be compatible with data available within the accounting system. This compatibility facilitates comparisons between actual expenditures in previous fiscal periods and proposed future expenditures and is essential for performance evaluation and financial reporting purposes. The Government Accounting Standards Board only has the ability to establish the format for budgetary comparisons. It cannot mandate the measurement focus or basis of accounting used to adopt the original budget and budget amendments or to present actual results. The budget comparison represents the only non-GAAP information currently found in basic financial statements. However, the budgetary process plays a unique role in the government financial environment. Therefore, some experts believe that a clear understanding of the financial position or changes in financial position cannot be achieved without the budgetary comparison and that presenting this information outside the realm of audited financial statements will diminish the importance associated with a government's annual financial report for some users of this information.

Governments may present the budgetary comparison statement using the same format, terminology, and classification as the budget document. Or the comparison may be made using the format, terminology, and classifications applied in a statement of revenues, expenditures, and changes in fund balances.

The revenue and expenditure data for the General Fund presented in Exhibit 3 are shown as a budget compasion in Exhibit 9.

Objects of Expenditure

Generally accepted accounting principles require that financial statements follow certain standards. One standard is that expenditures be classified by functions or programs. Another standard is that, in all cases in which a budget is used to appropriate moneys to funds, there be a statement that compares actual revenue and expenditures with budgeted revenue and expenditures. Therefore, whenever possible, the budget classification system should follow the accounting classification system. [6]

The basic control devices budgetary accounting are the objects of expenditure--the fundamental elements of an organization's operations in terms of the goods and services procured. Object or class codes are three- or four-digit numbers that are used to budget and record expenditures in considerable detail. These object codes (or class codes) provide uniformity in the tracking of expenditures through financial accounting procedures. Object codes can be further subdivided into sub-object classifications--for example, object code 1300: supplies and materials might be broken down into: 1310 office supplies; 1320 fuel supplies; 1330 maintenance supplies; 1340 operating supplies; 1350 chemicals and drugs; 1360 food supplies; and so forth.. Categories of supplies and materials can be further enumerated; for example, 1310 office supplies might be further delineated as follows:

A comparison at the object level of actual expenditures at the end of 8 months with the budgeted amounts for the Rurbana Sewer and Water Utility Commission is provided in Exhibit 10.

Objects of expenditures, in turn, can be aggregated under broad expenditure characteristics such as for current operations, capital expenditures, and debt service. They can also be assigned to and recorded as the expenditures of a specific organizational unit, activity classification, program or subprogram, and/or basic function of government. For example, the following sixteen-digit code:

21-01-102-1312-24560

might be used to record the requisition of data and word processing supplies (1312) by the Financial Management Department (102) under the general government function (21) in conjunction with the preparation of the annual budget report (24560). The code 01 might be used to designate the funding source (general funds) to which this expenditure is to be charged. The five-digit project code might also be used to designate the program or subprogram (24xxx) and the activity classification (xx56x). Using such multi-digit codes, accounting entries can be retrieved and sorted to meet a variety of fiscal management and reporting purposes.

The Accounting Equation for Governmental Funds

While budgetary accounting can be applied to any governmental funds, it is most appropriately used in connection with those funds in which broader accountability is required, such as the general fund and special revenue funds.

As noted previously, the basic accounting equation used in double entry accounting for business activities is:

Assets = Liabilities + Owner's Equity + Revenue - Expense

In dealing with governmental funds, the basic accounting equation must be changed to show expenditures instead expenses. An expense is a resource consumed during the accounting period--once written off as an expense, the resource has expired as an asset. An expenditure, on the other hand, is an amount of cash spent or to be spent during the accounting period. Since government funds do not include long-term assets or liabilities, expenditures and not expenses are measured in these accounts.

In addition, there is no owner's equity as such in governmental funds. Instead of owner's equity, the residual portion of the equation would be the fund equity or fund balance. Thus, the equation for governmental funds would read:

Current Assets = Current Liabilities + Fund Balance + Revenue - Expenditures

Only those assets that can be converted into cash in a relatively short period of time--no more than one year--are included in governmental funds. Similarly, liabilities in governmental funds are only those that would be paid in cash in a relatively short period of time. Exceptions to this general rule are bonds payable over an extended time period, which may be found in Special Assessment Funds.

Revenue is the equity in resources (other than proceeds from bond issues or transfers from other funds) that is received during the fiscal period and is available to be spent in that fiscal period. Expenditures are the resources that are expended during the fiscal year. Thus, if an agency has only a certain amount of resources available to expend, management must make certain that this amount is not overspent, or overcommitted for expenditure, during that fiscal period.

The fund balance is the difference between assets and liabilities and is determined by the excess of revenue over expenditures during the current or prior fiscal year. The fund balance may also include other resources, such as bond proceeds or transfers from other funds. This remaining fund balance can be used to provide resources for expenditures in the current or future years.

For budgetary accounting, four new items must be added to the equation. Estimated revenue is the amount of revenue anticipated over and above current assets that can be used as expendable resources for the fiscal period. Appropriations are the amounts of estimated resources provided by the legislative body for expenditure during the period and should be included on the liability and fund balance side of the equation. Encumbrances are used to obligate amounts for goods and services ordered but not yet received. Encumbrances are subtracted (shown as a minus figure) from the liability and fund balance side of the equation, just as expenditures are. The reserve for encumbrances is used to allocate a portion of the appropriations for the goods and services ordered but not yet received--shown an addition to the fund balance side of the equation.

A new equation for budgetary accounting of governmental funds can be developed using these new budgetary terms. The fund balance account often includes budgetary amounts, and therefore, it is shown as a budgetary element. Thus, the expanded equation is:

Assets + Estimated Revenue = Liabilities + Fund Balance + Revenue - Expenditures + Appropriations + Reserve for Encumbrances - Encumbrances

Estimates revenue is added to the left-hand side of the equation, while appropriations, and the net between the reserve for encumbrances and actual encumbrances is included on the right-hand side of the equation. The minus on the right side of the equation can be shifted to the left hand side to express all terms as positive values as follows:

Assets + Estimated Revenue + Expenditures + Encumbrances = Liabilities + Fund Balance + Revenue + Appropriations + Reserve for Encumbrances

The debit and credit conditions under budgetary accounting are summarized in Exhibit 10.

Exhibit 10. Debits and Credits to Accounts Under Budgetary Accounting

Bases for Accounting

An accounting basis provides the fundamental rules governing how and when revenues and expenditures are to be recorded. On the revenue side, two bases are possible: (1) cash basis and (2) accrued revenue basis. Four bases are used on outflow side: (1) cash, (2) obligations, (3) accrued expenditure, and (4) 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, revenues are recorded as soon as they are levied, billed, or earned, regardless of the fiscal period in which they are collected, and expenditures are recorded when goods are received or services are performed, when a liability is incurred, or when an invoice is received.

Various combinations are possible. A municipality may record revenues on a cash basis, for example, but accrue current expenditures and incurred obligations. Under a modified accrual basis: (1) revenues are recorded when received in cash, except for revenues susceptible to accrual (e.g., intergovernmental transfers); and (2) expenditures are recorded on an accrual basis except for disbursements for inventory-type items, prepaid expenses, and long-term debt. Under a modified cost basis, property taxes and other receivables are placed on the books for control purposes when they are levied, but are not accounted for as revenue until actually collected.

An example may help to clarify the distinctions among the various bases of accounting. The general fund of the city has $15 million in taxes receivable during the year, of which $12.5 million has been collected. During the year the following transactions took place:

These transactions would be recorded as follows:

Accounting becomes more refined as procedures shift in the following sequence: cash basis, modified cash basis, modified accrual basis, accrued expenditure basis, and finally, accrued cost basis. Reliable unit cost data cannot be developed on a strict cash basis. Most governments have adopted a system under which obligations are recorded (as encumbrances) at the time they are incurred.

Use of Subsidiary Ledgers

A running comparison of actual revenue and expenditures with budgeted revenue and expenditures should be maintained in any organization. Therefore, in addition to recording the journal entries in general ledger accounts, individual amounts are also recorded in a subsidiary ledger. Accounts would be kept in the subsidiary ledger for the particular budgeted revenue, appropriations, actual revenue, expenditures, and encumbrances accounts.

The Municipal Finance Officers Association, in its Governmental Accounting, Auditing, and Financial Reporting, provides an excellent statement concerning the purpose of subsidiary ledger accounts.

The General Fund of most governments has many sources of revenue and, hence, a need for numerous general ledger revenue accounts. A great many expenditure accounts are also normally required. Excessive general ledger accounts are very inconvenient to work with. Most governments, therefore, use general ledger control accounts and subsidiary ledgers.

A subsidiary ledger includes numerous detailed accounts, balances of which in total agree with the balance of a particular general ledger account. A general ledger account supported by a subsidiary ledger is called a general ledger control account. Through the use of subsidiary ledgers, a government can maintain a large number of individual accounts without cluttering up its general ledger. [7]

Records must be kept in much greater detail in the subsidiary ledgers for a breakdown of classes of revenue and expenditures than those usually shown in the general ledger. The general fund might include separate accounts for revenues from taxes, licenses and fees, intergovernmental transfers, and other financing sources. Local government revenues, for example, may include several types of licenses and permits--automobile licenses, business licenses, dog licenses, building permits, food vendor permits and so on--requiring subsidiary ledgers to track each of these sources. A single expenditure general ledger account often will also be supported by several different expenditure subsidiary ledgers to provide multiple expenditure classifications--by fund, function or program, organizational unit, activity, character, and object code.

By using subsidiary accounts and ledgers, it should be possible to provide the required detail on almost any revenue source and category of expenditure. Maintaining this level of detail in the general ledger would be almost impossible, even for a small municipality. Computerized data bases for financial operations usually included a structured chart of accounts which permits data to be "rolled up" from subsidiary ledgers to various levels of aggregation for financial management oversight and control.

Budget Adjustments

At times during the fiscal year, the budget may need to be adjusted to reflect additional information concerning estimated revenues and appropriations. Suppose, for example, that during the fiscal year it is determined that the estimated revenue for the Rurbana Sewer and Water Utility Commission will be $4.6 million instead of $4.5 million. The increase could be reflected in the fund balance account at the end of the year, and the estimated revenue account would not have to be adjusted. However, assume at the end of eight months that the annual expenditures for the Commission are projected to exceed $4,539,400. Unless a sufficient amount is available in the fund balance to meet agency commitments, the estimated revenue account would have to be adjusted before making any additional allocations.

During the fiscal year, it may become apparent that revenues are falling short of the initial estimates. If the fund balance is insufficient to cover the amount appropriated, it obviously becomes necessary to decrease the appropriation. Assuming that the estimate of the amount of revenue to be collected during the fiscal year is revised from $4,500,000 to $4,400,000, it then becomes necessary to revise the appropriation by the same amount. The budget adjustment would be:

Appropriation $100,000

Estimated Revenue $100,000

The amount that can be spent, then, would be only $4,350,000 instead of the original $4,450,000, assuming a projected fund balance of $50,000.

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. Under such procedures, agencies may be tempted to overobligate or overspend to ensure that no moneys are "left on the table." This practice can have significant consequences, however, if encumbrances are added to the accounting system. Suppose a piece of equipment is ordered near the end of the fiscal year at an estimated cost of $10,000. The $10,000 is encumbered and cannot be spent for other commitments. The equipment is not delivered before the end of the fiscal year, however, and the encumbered funds revert. A new encumbrance is processed in the next fiscal year, and in effect, the agency has paid for the equipment twice--once in terms of the reverted funds and secondly, when the new encumbrance is liquidated. This problems is minimized under an accrued cost basis, however, because unspent funds and encumbered obligations are carried over to the next fiscal period.

Closing entries at the end of the fiscal year may be made in one of two ways: (1) by reversing the budget adoption transactions or (2) by closing the actual revenue account to the budget revenue account (esti-mated revenue) and the actual expenditures account to the appropriation account. Any differences are then closed to the fund balance account.

Assume the following situation with regard to the Rurbana Sewer and Water Utility Commission: (1) encumbrances do not lapse--that is, they carry over to the next fiscal year; (2) the revised budget included an increase of $100,000 in estimated revenue and increased appropriations of $90,000; (3) actual revenue for the year totaled $4,600,000; (4) actual expenditures against the appropriations were $4,530,400; (5) appropria-tions of $6,000 were encumbered at the end of the year for supplies.

Using the first method, the closing entry made by reversing the original budget adoption entry would be:

The closing entry related to actual revenue, expenditures, and encumbrances is:

An alternative approach is to reverse the original encumbrance entry and place the difference in the fund balance account. Then the reserve for encumbrance amount is set up as a reservation of the fund balance. The encumbrance entry is reversed as follows:

Actual accounts are then closed:

A reservation of the fund balance is set up for the encumbered amount:

Using the second method of closing the accounts, revenue is closed to estimated revenue, with the difference going to the fund balance. This entry is:

Then the encumbrance account is closed to the appropriation account, leaving the reserve for encumbrance account open as a reservation of the fund balance. This entry is:

Finally, the expenditure account is closed to the appropriation account:

Summary

This chapter has attempted to provide a basic understanding of basic accounting procedures, particularly, as they are applied to governmental funds. Fund accounting serves as the foundation for the internal control system used to produce financial statements and reports that can be audited in accordance with generally accepted accounting principles. Budgetary accounting permits comparisons to be made between actual revenues and expenditures recorded during the fiscal year and revenues and expenditures included in agency budgets, as promulgated through the appropriation process. The intent has not been to prepare managers to carry out the complex duties and responsibilities of accountants, but rather to provide a basic vocabulary and appreciation of the role of accounting in the management planning and control process. [8] Budgetary and related accounting systems can also be further adapted to appropriate managerial accounting systems useful for decision making and control processes in government and other not-for-profit organizations.

Endnotes

[1] Henri Fayol, General and Industrial Management (New York: Pitman Corporation, 1949), p. 107.

[2] W. A. Paton, Accounting (New York: The Macmillan Company, 1926), p.71.

[3] Charles T. Horngren, Introduction to Management Accounting (Englewood Cliff, N.J.: Prentice-Hall, Inc., 1978), p. 555.

[4] Municipal Finance Officers Association of the United States and Canada, Statement 1. Governmental Accounting and Financial Reporting Principles (Chicago, Ill.: 1979), pp. 5-6.

[5] Governmental Accounting Standards Board, State and Local Government Reporting Model: Exposure Draft Proposal (1997), Paragraph 118. The notion of major funds is not applicable to fiduciary funds (trust and agency), including pension trust funds used to report defined benefit pension plans. The GASB has also concluded that internal service funds should be exempt from the major fund reporting requirements.

[6] The Governmental Accounting Standards Board continues to support a requirement to provide budgetary comparisons, but has altered its position that the statement should be a basic financial statement. Rather, the GASB believes that this information is more appropriately presented as required supplementary information. The purpose of budgetary comparisons is to show whether resources were obtained and used in accordance with the entity's legally adopted budget.

[7] Municipal Finance Officers Association of the United States and Canada, Governmental Accounting, Auditing and Financial Reporting (Chicago, Ill.: 1981), p. 37.

[8] For a more comprehensive discussion of the principles and practices of accounting in the public sector, see: Leo Herbert, Larry N. Killough, and Alan Walter Steiss, Accounting and Control for Governmental and Other Nonbusiness Organizations (New York: McGraw-Hill, 1986).

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