25. Introduction to School Accounting

Transcription

1 Financial and Education Law Training Program Page Background and Introduction During the early years of American education, financial records were not extensive because local school systems were small and had relatively few financial transactions. Also during this developmental period, most school funds were derived from local sources and there was little need for comparative reporting statewide. In fact, there was no need for one state s record keeping procedures to look like that of any other. Most local schools developed at the township level and basically comprised a self-contained financial and operational unit. The growing importance of good business practice in education was exemplified in 1841 when Cleveland, Ohio hired a manager to attend to the accounting functions of the district. By the twentieth century, state funding of public schools began to emerge as states levied broad based taxes such as the sales tax and the income tax for state operations. In addition, the development of equalization formulas required the development of standardized recording and reporting. Financial bookkeeping developed into financial accounting, the art of recording, classifying, summarizing, reporting, and interpreting the results of the financial activities of the organization. The Association of School Business Officials was founded in 1910 to provide programs and services to promote the standards of school business management practices, growth, and the effective use of educational resources. Participating in the local development of standardizes financial practices and procedures during the first half of the twentieth century, the Association of School Business Officials pressed the need for some standardized accounting system on a nationwide basis for local school systems. In cooperation with the Association of School Business Officials, the US Office of Education in 1953 began a series of publications in the State Educational Records and Reports Series to guide and standardize local school system accounting and reporting. In 1957, the second handbook in the series was published entitled Handbook II, Financial Account for State and Local School Systems. The current publication commonly know as Handbook II Revised is officially titled Financial and Accounting for Local State School Systems 1990 and is published by the US Department of Education, Office of Educational Research and Improvement (NCES R). National Center for Education Statistic's and Education Data Systems The National Center for Education Statistics (NCES) has a responsibility to provide and interpret comprehensive statistics about the condition of education in the United States. In addition, it has congressional mandates calling for conducting and publishing specialized analyses and for providing assistance to States and Local

2 Financial and Education Law Training Program Page 25-2 Education Agencies (LEAs) in improving their statistical activities. To fulfill its role, NCES sponsors a number of programs, ranging from regular data collection to the development of materials and techniques that facilitate the compilation and comparisons of statistical information. One of these programs is the development and periodic revision of manuals of standardized terminology. Financial Accounting for Local and State School Systems is one of several publications sponsored by NCES in a coordinated attempt to produce comprehensive and compatible sets of standardized terminology for use in education management and reporting. NCES encourages states to use these guidelines in planning new recording and reporting systems. State and local school administrators realize the value of having well-organized, standard items of comparable data at their disposal for management and reporting purposes. As a result, many of the Nation's school systems and many Federal and State Reports use these guidelines, terms, and definitions. The National Center for Education Statistics (NCES) is the primary federal entity for collecting and analyzing data that are related to education in the U.S. and other nations. NCES is located within the U.S. Department of Education and the Office of Educational Research & Improvement. In fulfilling this role, NCES sponsors a number of programs, ranging from regular data collection to the development of materials and techniques that facilitate the compilation and comparison of statistical information. One of these programs is the development and periodic revision of manuals of standardized terminology. Financial and Accounting for Local State School Systems 1990 is one of several publications sponsored by NCES is a coordinated attempt to produce comprehensive and compatible sets of standardized terminology for use in education management and reporting. Adoption of the standardized terminology and procedures contained in Financial and Accounting for Local State School Systems 1990 is not required by Federal law. NCES does not mandate their use at either the state, intermediate, or local level. NCES does encourage state and local school systems to use these terminology and procedures in their planning of new recording and reporting systems. Many of the nation s school systems do use these standardized terminology and procedures and most federal and state reports do utilize its terms and definitions. The Role of the Governmental Accounting Standards Board (GASB) The Governmental Accounting Standards Board (GASB) is the private, nonpartisan, nonprofit organization that works to create and improve the rules the federal, state, and local governments (including school systems) follow when accounting for their finances and reporting them to the public. The GASB was founded under the auspices of the Financial Accounting Foundation (FAF), which appoints the GASB s board, raises its funds, and oversees its activities. The FAF performs the same functions for the GASB s private-sector counterpart, the Financial Accounting Standards Board (FASB). The Foundation is not involved, however, in the standards-

3 Financial and Education Law Training Program Page 25-3 setting activities of either board. The GASB was created in 1984 to succeed the National Council on Governmental Accounting (NCGA) by agreement among the following: The Financial Accounting Board; The American Institute of Certified Public Accounts (AICPA); The Government Finance Officers Association; The International City/County Management Association; The National Association of Counties; The National Association of State Auditors, Comptrollers, and Treasurers; The National Conference of State Legislators; The National League of Cities; The National Governor s Association; and The U.S. Conference of Mayors. Although the GASB does not have the power to enforce compliance with the standards it promulgates, the authority for its standards is recognized under the Rules of Compliance of the American Institute of Certified Public Accountants. Also, legislation in many states requires compliance with GASB standards, and school systems are usually expected to prepare financial statements in accordance with those standards when they issue bonds or warrants or otherwise borrow from the public sector. The mission of GASB is to establish and improve standards of state and local governmental accounting and reporting to result in useful information for users of financial reports and guide and educate the public, including issuers, auditors, and users of those financial reports. These standards are essential to the efficient and effective functioning of our democratic system of government. They improve school system s and other government s ability to demonstrate their stewardship to the public; and comparable information available to the public for holding school systems and governments accountable. For this to be accomplished, it is imperative that a uniform system of accounting and reporting be implemented in governmental accounting. What is the Purpose of the Accounting System? What is an accounting system? How does it go about serving the diverse needs of its users? An accounting system is that combination of people, equipment, forms, methods and procedures organized to record financial activity and to display that activity in the financial reports. A primary purpose of an accounting system is to produce financial information organized in various ways for various uses. The purposes of this

4 Financial and Education Law Training Program Page 25-4 document are to: (1) describe the need for and advantages of the account classification system contained in this document; (2) define the systems framework envisioned in the coding structure; (3) clarify the multiple uses that can and should be made of that coding structure; and (4) help the reader understand what may appear to be an imposing system. What Is The Accounting System Composed of? The accounting system is the means by which financial data are captured during actual operation of the LEA, recorded in the books of account, and then analyzed to produce the various kinds of reports needed. Financial transactions can be classified to facilitate their accumulation in the categories needed on the required reports. The guidelines which follow provide a classification structure which will meet most of the accounting system's needs and will provide comparability of reported data when reports from different LEAs are combined, compared, or both. Basic Philosophy of Uniform Financial Accounting Several criteria are inherent in the design of the account classification structure. Taken together, they support the needs of categorizing and reporting financial transactions. They are as follows: 1. The chart of accounts encourages full disclosure of the financial position of the LEA. Emphasis is placed on the accurate classification of financial transactions. Expenditures are recorded in the accounting categories applicable, regardless of the implications of some of those decisions. 2. Comprehensiveness of financial reporting is encouraged. The LEA should incorporate all financial activities into a single accounting and reporting system for full disclosure. The account classifications here encourage this procedure. Accounts for such activities as food services, student activities, community services and commercial-like enterprises all should be included in the financial reports of the LEA. 3. Simplified reporting is encouraged. GAFR encourages using the minimum number of funds necessary for legal and operational use. Only the minimum number of funds consistent with legal and operating requirements should be established, since unnecessary funds result in inflexibility, undue complexity, and inefficient financial administration. 4. Financial reporting emphasizes the results of LEA operations more than the resources applied. The account code structure emphasizes program accounting and the application of supporting services costs to the "products" of the educational enterprise.

5 Financial and Education Law Training Program Page The account classification system is flexible: it meets the needs of both small and large LEAs while retaining comparability of reported data. The guidelines here include a minimum list of accounts essential for Federal reporting. They also provide a variety of optional classifications for LEAs interested in a more comprehensive approach to financial accounting and reporting; 6. The classification of accounts and the recommended reporting structure remain in accordance with generally accepted accounting principles. Users of the LEA Uniform Financial Accounting System Educational accounting and financial reporting systems must satisfy a number of objectives simultaneously. Most succinctly "... governmental accounting exists for the purpose of providing complete and accurate financial information, in proper form and on a timely basis, to the several groups of persons responsible for, and concerned with, the operations of governmental units and agencies..." (National Committee on Governmental Accounting, Governmental Accounting, Auditing and Financial Reporting, published by Municipal Finance Officers Association, Chicago, Illinois, 1968, page 1). The groups most interested in the output of the financial reporting system are: school administrators, school boards and other governing units, Congress and State legislative bodies, creditors, and the general public, including taxpayers School Administrators and Other Employees First and foremost, school administrators use the Uniform Financial Accounting account classification system. They must rely on financial reports to evaluate past performance, to aid in day-to-day decision making and to inform the general public. Budgeting, an important managerial tool for the public school administrator relies upon correct and properly classified accounting information. The expenditure dimensions used here offer the administrator a variety of methods for budgeting and permit local judgment about the most appropriate technique. Additionally, the accounting system satisfies the administrator's obligation to ensure compliance with the legal, regulatory and fiduciary responsibilities of that position of public trust. This publication is designed to meet these overlapping requirements. School Boards and Other Governing Units School boards and other governing units have both a responsibility and an intense interest in the operation of the school system. The school board is responsible for establishing policies and for overseeing and appraising the administrator as he or she carries out these policies. The school board thus needs timely warning in case situations develop that require corrective action. The board also needs information as a basis for judging both the efficiency of the administration and its effectiveness in

6 Financial and Education Law Training Program Page 25-6 complying with policies and restrictions. Some of this information can be provided by general-purpose financial reports. Comparable information obtained about other LEAs also is needed as a basis for comparison. Congress and State Legislative Bodies The U.S. Congress and the State legislatures provide about half of the resources for the operation of LEAs in the country today. Accordingly, they need information on the schools' operations as a basis for deciding whether to commit additional resources, and how much. Additionally, governance units need cumulative information (in compatible format) about the operations of groups of LEAs in order to formulate funding policies. To this end, legislators are interested in such matters as: the ways in which local, State and Federal programs interact within specific operational areas; profiles of school finance structures as they relate to tax resources; and the impact (and cost) of programs resulting from specific legislative initiatives. Hence, characteristics of the accounting and reporting system of interest to State and Federal legislators are comparability of data, ability to achieve a variety of classifications and timeliness in reporting. Creditors and Potential Creditors In governmental accounting, creditors are considered to include bondholders and prospective bondholders, commercial banks, vendors, and others who have extended credit, or who are considering extending credit, to the LEA. Typically, they would be interested in the financial position of the organization, its operating performance, and its likely sources and uses of funds as indications of the probability that the bonds or loans will be repaid in full and on time. The General Public With regard to the general public's interest, in theory, a governing body represents the interest of an organization's constituents (taxpayers, members, the general public, etc.). In fact, however, the constituents need to check on how well governing bodies do represent their interests. In a general way, the interests of constituents are similar to those of resource providers: they want to know the nature of the organization's activities and how effectively and efficiently it was managed. Constituents have a more personal interest in these matters, however. Taxpayers want to know about the services furnished by the governmental unit. An American Accounting Association committee states bluntly that an objective of financial statements is to provide information on which constituents can base a decision to retain or replace incumbents. The account classification system presented here is designed to enable LEAs to produce the financial reports necessary to better meet all of these

7 Financial and Education Law Training Program Page 25-7 potential users. Governmental vs. Commercial Accounting Governments have objectives different from business enterprises, and operate in different economic, legal, political and social environments. These differences often require accounting and financial reporting techniques that are unique to government. There are many similarities between governmental accounting and commercial, or private enterprise accounting. Both are concerned with controlling and reporting on financial position and results of operations. Both emphasize relevance, materiality, freedom from bias, comparability, consistency, and understandability. However, for a government such as a local school system, the bottom line usually is not an accurate measure of its success. A government s primary objective is to provide services to its constituents within budgetary constraints with little regard to the bottom line concept. An alternative measure of a government s success might be the cost effectiveness of providing services. In business, substantial discretion is allowable in securing and utilizing resources. By comparison, the financing and spending activities of local government are subject to very specific legal and contractual provisions. By contrast, finance-related legal requirements on many governments include limits of the power to raise revenues or taxes, limits on amount of bonds that can be sold, limits on expenditure, accounting requirements, and financial reporting requirements. Most forms of government, especially school systems, adopt an annual operating budget that describes just where the money to operate the governmental unit comes from and how it will be spent. The role of a government s annual operating budget is different from that of business. For government that assists not only as the internal planning tool as in the case of business, but also serve an external function. Parties inside and outside of the governmental unit (the public) may participate in the development of the budget. Often there is great public interest in budget hearings because it is the taxpayer s dollar that is being budgeted to be spent. And once the budget is approved, spending limits are established and cannot normally be exceeded. The constraints on governmental budgeting and spending create limitations, which normally do not exist in the commercial section. These same constraints to a large degree determine how the governmental accounting and financial reporting system must work. Both governmental and commercial systems utilize the following elements within their accounting and reporting system: Double entry bookkeeping Many common terms (e.g., balance sheets, assets, liabilities, equity)

8 Financial and Education Law Training Program Page 25-8 Common accounting processes (e.g., journalizing, posting to ledgers, preparing of financial statements). The significant differences between the two types of accounting can be summarized as follows: Objectives - While commercial enterprises are organized to make a profit for their owners, governmental entities exist to provide services to their citizens on a non-profit basis. Even though some district activities, such the food service program or the student store, provide commercial-like services, their primary objective usually is not to earn a profit. Reporting emphasis - Since governmental entities are primarily not seeking to increase capital, the accounting emphasis is not on profit. This emphasis requires the reporting of revenues and other financing sources (i.e., sale of bonds, interfund transfers) and expenditures and other uses of funds (i.e., interfund transfers, purchase of fixed assets, debt retirement) in the operating statements rather than on the balance sheet. Legal requirements and restrictions - Since governmental entities are created by law, they are continuously regulated by legal provisions. Their accounting records must illustrate that they have complied with all applicable laws and regulations. Most small commercial enterprises have more flexibility in their accounting processes than do governmental entities. Fund accounting - Because of these legal provisions and the diverse nature of governmental bodies, fund accounting is required. A fund is defined as a separate, self-balancing set of accounts, which is separated for the purpose of carrying on specific activities or attaining certain objectives. Unlike a commercial enterprise, governmental entities must maintain separate funds, requiring a self-balancing set of accounts for each fund. These and other characteristics of governmental accounting are formalized in a set of generally accepted accounting principles (GAAP) for governmental accounting, which are unique to government and local school systems. The Governmental Accounting Standards Board (GASB) creates the accounting and reporting rules for governmental entities; the Financial Accounting Standards Board (FASB) creates the accounting and reporting rules for business. In addition to GASB standards, many states issue their own accounting rules that local governments must follow. GAAP and Legal Compliance Guidelines for financial accounting and reporting are derived from generally

9 Financial and Education Law Training Program Page 25-9 accepted accounting principles (GAAP). LEAs are required to adhere to GAAP. Legal and contractual considerations typical of the government environment are reflected in the fund structure basis of accounting and are a major factor distinguishing governmental accounting from commercial accounting. Governmental financial operations are regulated by various kinds of legal provisions. Other types of financial matters often are also regulated by charters, ordinances, resolutions, governing body orders, and intergovernmental grant or contract regulations. The annual operating budget is one of the most important of all legal documents governing financial transactions. Upon board approval, the expenditure requests in the budget become binding appropriations that may not legally be exceeded by the school district without an amendment. An important function of governmental accounting systems is to enable administrators to assure and report on compliance with financerelated legal provisions. This assurance and reporting means that the accounting system, its terminology, fund structure and procedures must be adapted to satisfy finance related legal requirements. However, the basic financial statements of LEAs should be prepared in conformity with GAAP. In some instances legal provisions may conflict with GAAP. These differences often occur because constitutional, charter or other legal provisions governing fiscal operations are difficult to change. Conflicts between legal provisions and GAAP do not require maintaining two accounting systems. Rather, the accounting system may be maintained on a legal compliance basis but should include sufficient additional reports to permit GAAP- based reporting. If a school district prepares the budget on the cash basis or another basis not consistent with GAAP, financial management and reporting becomes complicated. If legal requirements dictate another basis of accounts or reports, school districts should maintain the accounts and prepare budgetary reports on the legally prescribed budgetary basis to determine and to demonstrate legal compliance and maintain sufficient supplemental records to permit presentation of financial statements in conformity with GAAP. When financial statements prepared in conformity with GAAP do not satisfy legal and contractual requirements, the school district should present such additional schedules and narrative explanations in the comprehensive annual financial report as may be necessary to report its legal compliance responsibilities and accountabilities. Accounting as Accountability Accounting is the mechanism by which the vast majority of school system accountability actually is implemented. The most important aspect of a school system s operation to many people is the management of the single resource (money) necessary to operate all aspects of the educational program. An accounting system is the means by which financial transactions are planned, captured during the actual operation of the

10 Financial and Education Law Training Program Page school system, recorded in the books of accounts, and then analyzed to produce the various reports for management, financial status and accountability. The Accounting System Required by GASB The accounting system is the means by which financial data are captured during actual operation of the LEA, recorded in the books of account, and then analyzed to produce the various kinds of reports needed. Financial transactions can be classified to facilitate their accumulation in the categories needed on the required reports. The guidelines, which follow, provide a classification structure, which will meet most of the accounting system's needs and will provide comparability of reported data when reports from different LEAs are combined, compared, or both. Accounting Principles and Policies Principles and policies adopted by the Legislature, the State Board of Education, and the Examiners of Public Accounts are official rules and constitute minimum budgeting, accounting, auditing and reporting requirements for local school systems. The state board of education intent in prescribing these rules is to cause the budgeting and financial accounting and reporting system of local school systems to conform with generally accepted accounting principles (GAAP) established by the Governmental Accounting Standards Board (GASB) and the Financial Accounting Standards Board (FASB) for accounting treatments not specified in GASB pronouncements. Codification of Governmental Accounting and Financial Reporting Standards (GASB Codification) Section 1100, "Summary Statement of Principles," defines twelve principles of accounting and reporting shown in the following Exhibit: Summary Statement of Principles of Accounting and Reporting (as adapted from GASB Codification Section 1100) Accounting and Reporting Capabilities - A governmental accounting system must make it possible both: (a) to present fairly and with full disclosure the financial position and results of financial operations of the funds and account groups of the governmental unit in conformity with generally accepted accounting principles, and (b) to determine and demonstrate compliance with finance-related legal and contractual provisions. Fund Accounting Systems - Governmental accounting systems should be organized and operated on a fund basis. A fund is defined as a fiscal and accounting entity with a selfbalancing 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. Types of Funds - The following types of funds should be used by state and local governments: Governmental Funds

11 Financial and Education Law Training Program Page (1) The General Fund - to account for all financial resources except those required to be accounted for in another fund. (2) Special Revenue Funds - to account for the proceeds of specific revenue sources (other than expendable trusts or for major capital projects) that are legally restricted to expenditure for specific purposes. (3) Capital Projects Funds - to account for financial resources to be used for the acquisition or construction of major capital facilities (other than those financed by proprietary funds and Trust funds). (4) Debt Service Funds - to account for the accumulation of resources for, and the payment of, general long-term debt principal and interest. Proprietary Funds (5) Enterprise Funds - to account for operations (a) that are financed and operated in a manner similar to private business enterprises - where the intent of the governing body is that the costs (expenses, including depreciation) of providing goods or services to the general public on a continuing basis be financed or recovered primarily through user charges; or (b) where the governing body has decided that periodic determination of revenues earned, expenses incurred, and/or net income is appropriate for capital maintenance, public policy, management control, accountability, or other purposes. (6) Internal Service Funds - to account for the financing of goods or services provided by one department or agency to other departments or agencies of the governmental unit, or to other governmental units, on a cost-reimbursement basis. Fiduciary Funds (7) Trust and Agency Funds - to account for assets held by a governmental unit in a trustee capacity or as an agent for individuals, private organizations, other governmental units, and/or other funds. These include (a) expendable trust funds, (b) nonexpendable trust funds, (c) pension trust funds, and (d) agency funds. Number of Funds - Governmental units should establish and maintain those funds required by law and sound financial administration. Only the minimum number of funds consistent with legal and operating requirements should be established, however, because unnecessary funds result in inflexibility, undue complexity, and inefficient financial administration. Accounting for Fixed Assets and Long-Term Liabilities - A clear distinction should be made between (a) fund fixed assets and general fixed assets and (b) fund long-term liabilities and general long-term debt. (a) Fixed assets related to specific proprietary funds or Trust funds should be accounted for through those funds. All other fixed assets of a governmental unit should

12 Financial and Education Law Training Program Page be accounted for through the General Fixed Assets Account Group. (b) Long-term liabilities of proprietary funds and Trust funds should be accounted for through those funds. All other unmatured general long-term liabilities of the governmental unit should be accounted for through the General Long-term Debt Account Group. Valuation of Fixed Assets - Fixed assets should be accounted for at cost or, if the cost is not practicably determinable, at estimated cost. Donated fixed assets should be recorded at their estimated fair value at the time received. Depreciation of Fixed Assets (a) Depreciation of general fixed assets should not be recorded in the accounts of governmental funds. Depreciation of general fixed assets may be recorded in cost accounting systems or calculated for cost finding analyses; and accumulated depreciation may be recorded in the General Fixed Assets Account Group. (b) Depreciation of fixed assets accounted for in proprietary fund should be recorded in the accounts of that fund. Depreciation is also recognized in those Trust Funds where expenses, net income, and/or capital maintenance are measured. Accrual Basis in Governmental Accounting - The modified accrual basis of accounting, as appropriate, should be utilized in measuring financial position and operating results. (a) Governmental fund revenues and expenditures should be recognized on the modified accrual basis. Revenues should be recognized in the accounting period in which they become available and measurable. Expenditures should be recognized in the accounting period in which the fund liability is incurred, if measurable, except of unmatured interest on general long-term debt, which should be recognized when due. (b) Proprietary fund revenues and expenses should be recognized on the accrual basis. Revenues should be recognized in the accounting period in which they are earned and become measurable; expenses should be recognized in the period incurred, if measurable. (c) Fiduciary fund revenues and expenses or expenditures (as appropriate) should be recognized on the basis consistent with the fund's accounting measurement objective. Nonexpendable Trust Funds should be accounted for on the accrual basis; Expendable Trust Funds should be accounted for on the modified accrual basis. (d) Transfers should be recognized in the accounting period in which the interfund receivable and payable arise. Budgeting, Budgetary Control, and Budgetary Reporting (a) An annual budget(s) should be adopted by every governmental unit. (b) The accounting system should provide the basis for appropriate control. (c) Budgetary comparisons should be included in the appropriate financial statements

13 Financial and Education Law Training Program Page and schedules of governmental funds for which an annual budget has been adopted. Transfer, Revenue, Expenditure, and Expense Account Classification (a) Interfund transfers and proceeds of general long-term debt issues should be classified separately from fund revenues and expenditures or expenses. (b) Governmental fund revenues should be classified by fund and source. Expenditures should be classified by fund and source. Expenditures should be classified by fund, function (or program), organization unit, activity, character, and principal classes of objects. (c) Proprietary fund revenues and expenses should be classified in essentially the same manner as those of similar business organizations, functions, or activities. Common Terminology and Classification - A common terminology and classification should be used consistently throughout the budget, the accounts, and the financial reports of each fund. Interim and Annual Financial Reports (a) Appropriate interim financial statements and reports of financial position, operating results, and other pertinent information should be prepared to facilitate management control of financial operations, legislative oversight, and, where necessary or desired, for external reporting purposes. (b) A comprehensive annual financial report covering all funds and account groups of the governmental unit -- including appropriate combined, combining, and individual fund statements; schedules' narrative explanations; and statistical tables -- should be prepared and published. (c) General purpose financial statements may be issued separately from the comprehensive annual financial report. Such statements should include the basic financial statements and notes to the financial statements that are essential to fair presentation of financial position and operating results (and changes in financial position of proprietary funds and similar Trust Funds). (d) The financial reporting entity consists of (1) the primary government, (2) organizations for which the primary government is financially accountable, and (3) other organizations for which the nature and significance of their relationship with the primary government are such that exclusion would cause the reporting entity's financial statements to be misleading or incomplete. The reporting entity's financial statements should present the fund types and account groups of the primary government (including its blended component units, which are, in substance, part of the primary government) and provide an overview of the discretely presented component units. (e) The nucleus of a financial reporting entity usually is a primary government. However, a governmental organization other than a primary government (such as a component unit, joint venture, jointly governed organization, or other stand-alone government) serves as the nucleus for its own reporting entity when it issues separate financial statements.

14 Financial and Education Law Training Program Page All of the concepts, terms, and definitions reported above will be developed in the following discussions. In order for these principals to be development, maintained, and reported, all financial transactions must be systematically accounted for. This requires record keeping in accordance with a standardized Chart of Accounts. The Chart of Accounts The Chart of Accounts and the General Ledger A list of all the accounts of an LEA and the numbers assigned to the accounts is called a Chart of Accounts. The identification of the specific accounts to be used by an LEA should be one of the first steps in setting up the accounting system. New accounts may be added, or unnecessary ones may be deleted once the system is in use. In order for a district to utilize the accounting process, books and records must be maintained. These books and records or bookkeeping records may be classified into two major types; journals and ledgers. Journals. A journal is a book of original entry. It is like a log book or a diary: that is, transactions are entered in it in the sequence in which they occur, in date order. As transactions occur, they are recorded first in the journal. This recording is called a journal entry and contains a summary of the transaction, the date on which the transaction took place, the accounts affected, how they are affected (whether debits or credits), the amounts to be debited or credited, and a brief description of the nature of the transaction. A journal is classified as a general journal or a special journal. Special journals are used to record transactions of a like nature. Some examples of special journals include: revenue journal receipts journal expenditures journal disbursements journal payroll journal (payroll register) purchase order journal All transactions could be recorded in a general journal but this would be unwieldy to ever be practicable. In maintaining the books, records, and journals, each fund is defined as a separate group of self-balancing accounts. For accounts to be self-balancing, the totals of the accounts having debit (Dr) balances must equal the totals of the accounts having credit (Cr) balances. An account is the device that accumulates the net effect of all

15 Financial and Education Law Training Program Page financial transactions on one item of assets, liabilities, fund balance, revenue, or expenditure. For example, the cash account in the General Fund will show all the transactions that affected cash in the General Fund for a given period of time. All the accounts within each fund will be classified as either an asset, a liability, a fund balance (or retained earnings), a revenue, or an expenditure (expense) account. The revenue and expenditure accounts are referred to as temporary, or nominal, accounts because they are closed out at the end of the year and become part of the fund balance. These revenue and expenditure accounts are reopened at the beginning of each fiscal year. The asset, liability, and fund balance accounts are permanent, or real, accounts that exist throughout the life of a fund. These accounts are not closed at the end of the year. The General Ledger A ledger is a group of accounts. A General Ledger is defined as the book, file, computer run, or other device which contains the accounts that are necessary to reflect in summary or in detail the financial operations and the financial condition of the local educational agency (LEA). However, there can be a Ledger for a fund will show the group of self-balancing accounts for that fund. Ledger accounts may be kept for any group of items or expenditures on which an administrative officer wishes to maintain a close check. A Ledger will be maintained for each fund of an LEA. The sequence of accounts in the General Ledger will follow the order in which the accounts are presented in the financial statements assets first and then liabilities, fund balance, revenues, and expenditures. When all asset, liability, expenditure, revenue, and fund balance accounts are grouped together they make up the General ledger of the LEA. Most commonly the General Ledger is referred to as the book, file, or other device in which accounts are kept to summarize the financial transactions of the local school system. The Subsidiary Ledgers Computerized accounting systems are capable of handling a large number of accounts and transactions. They therefore may not use the traditional subsidiary ledgers and control accounts that were necessary for a manual accounting system. However, some computerized systems have maintained the structure of subsidiary ledgers to support general ledger control accounts. When it is necessary to provide more detail regarding accounts in the General Ledger, special ledgers, called subsidiary ledgers, are maintained. The subsidiary ledgers support accounts, called control accounts, in the General Ledger. Closing the General Ledger

16 Financial and Education Law Training Program Page At the end of each fiscal year, the books (General Ledger) of the LEA are closed. Closing the books is the accounting process in which the accounts are adjusted to reflect the most current balances, and the budgetary and operating accounts of the LEA are closed. Closing the books separates the financial transactions by year and measures the results of operations of a fund for the year. The closing process is accomplished through adjustments of prior years accruals, the current year s accruals, and closing entries. Completing the closing of the books is the creation of the annual financial reports generally known as General Purpose Financial Statements (GPFS). Principals of Accounting The first principle of instituting an accounting system is The Accounting Equation. Understanding the accounting system requires mastering the basic principles, procedures, and terminology of accounting. Financial accounting is based upon the principle that what one owns less what one owes equals equity. In equation form, this principle is as follows: Owned - Owed = Equity Another way of expressing this is in accounting terms where Assets are things of value owned and Liabilities are debts owed. Equity is then the difference between Assets and Liabilities. Assets Liabilities = Equity This fundamental equation from Algebra can be expressed in three ways: Assets, Liabilities, and Equity Defined (1) Assets Liabilities = Equity (2) Equity = Assets + Liabilities (3) Assets = Liabilities + Equity Assets. In the language of accounting assets are things of value which a local school system owns or controls. These assets can either be current or fixed. A current asset is cash or anything that can readily be converted into cash. Examples follow: (1) Cash; (2) U.S. Treasury notes or bonds held by a local school system; (3) Supplies in a stockroom; (4) A check awaiting deposit in a bank; (5) A certificate of deposit from a bank; and (6) Accounts receivable such as money due the local school system from the state, but not yet paid; or property taxes due, or tuition due, etc. A fixed asset is an item of value owned by the school district which is not likely to be

17 Financial and Education Law Training Program Page sold for cash. Examples follow: (1) Land; (2) Buildings; and (3) Equipment. Liabilities. In the language of accounting, liabilities are any debts the local school system owes. As with assets, liabilities may be classified either as current or longterm. A current liability is any debt which the local school system expects to pay within a short period of time, usually a year or less. Examples follow: (1) An invoice for textbooks purchased; (2) A bill payable to a vendor for food delivered to the cafeteria; (3) Two months salary earned by a teacher where payment is deferred until the summer; (4) Income tax withholdings from salaries of employees not yet paid to the US government; and (5) A short-term note held by a bank for money borrowed by the local school system. A long-term liability is one which the local school system is not likely to pay within a year. The most common types are bond issues and revenue warrants. Equity or Fund Balance. The excess of assets over liabilities is equity. However, this term is not normally used; rather the excess of assets over liabilities is generally called the Fund Balance. Therefore, the accounting equation becomes Assets = Liabilities + Fund Balance Accounts When a local school system makes a purchase or pays teachers or receives taxes or engages in any business affecting the financial condition of the system, it is transacting business. Therefore, such business dealings are called transactions. All transactions are first recorded in a journal and are posted from the journal to an account. Transaction Journal Entry Account Entry The journal entry or first recording of a transaction is called a journal entry and is a summary of the transaction. It would consist of the date on which the transaction took place, the accounts that will be affected and how they will be affected, and a brief description of the transaction. The transaction will be recorded in the journal and shown

18 Financial and Education Law Training Program Page as either a debit or a credit. After the transaction is recorded in the journal, it is later posted to the proper account. A journal and an account look like a T. The left side of an account is called the debit side and the right side is called the credit side: Debit Side (left side) owes Credit Side (right side) owed These terms are derived from Latin words. The Latin word debeo means owe. The history of the use of this word as it applies to accounting began when the only transactions necessary to be recorded were those with customers or suppliers. A charge against a person who owes appears of the left side of the account with that person. The left side of the account is therefore the debit side. The Latin word credo means trust or believe. The history of this word as it applies to account began at the same time as the word debit. The amount shown as owed to a person who trusts us appears on the right side of the account, which is referred to as the credit side. To keep the accounting equation in balance, there must be an equal use of debits and credits for each transaction. A single transaction must have two or more debits and two or more credits. However, the total amount of debits must still equal the total amount of credits. Therefore, in any series of transactions the sum of the debits must equal the sum of the credits. This system in which accounts are self-balancing through equal entry of both debits and credits is known universally as double-entry bookkeeping. However, this in itself is not accounting. Bookkeeping is a part of accounting that involves only the recording of business events. In addition to the debits and credits to an account in double-entry bookkeeping are also posted not only the amounts of the transaction, but also the date, a brief description and the journal page number for reference (the page on which the transaction was originally recorded). The act of entering an amount of the left side of an account is called debiting the account, and making an entry on the right side is called crediting the account. The procedure of having debits on the left and credits on the right is an accounting custom or rule. This rule applies to all accounts. In the case of assets, recording the value of an asset in the left or debit side of the account increases the amount of the asset. Decreases in the amount of an asset are recorded in the right or credit side of the account. For example, consider the

19 Financial and Education Law Training Program Page following cash transactions for a school system account placed in a tabular summary of cash transactions: Tabular Summary Cash $15, , , , $8, However, when this information is placed in Account Form in an assets account, it appears as follows: Account Form Summary Cash Debits $15, Credits $7, , , , Balance $8, Owed to the account: The account owes: Note that increases in the value of the asset or cash (debits) are recorded on the left side of the account and decreases in the value of the asset or cash (credits) are recorded on the right side of the account. Every positive item in the tabular summary represents a receipt of cash whereas every negative amount in the tabular summary represents a payment out of cash. The account balance thus indicates that receipts of cash exceeded payments of cash by $8, In the case of accounting for liabilities, the amount of a liability and increases in the liability are recorded in the right or credit side of the account. Decreases in the amount of liability are recorded in the left side or debit side of the account. Debits thus

20 Financial and Education Law Training Program Page increase assets and decrease liabilities. Credits decrease assets and increase liabilities. DEBITS Increase Assets Decrease Liabilities CREDITS Decrease Assets Increases Liabilities Under normal circumstances, asset accounts should show debit balances and liability accounts should show credits balances. This procedure summarizes the basic double entry accounting which is standard in governmental accounting. The accounting system is organized on a fund basis. This topic follows in the next module. Basis of Accounting Another principal of account, The "basis of accounting," refers to the point in time when revenues, expenditures or expenses (as appropriate), and the related assets and liabilities are recognized in the accounts and reported in the financial statements. In other words, the "basis of accounting" determines the timing with which the accounting system recognizes transactions. Cash-Basis Accounting Cash-basis accounting recognizes transactions when cash is received or disbursed. In the most common version of a cash-basis accounting system, the financial condition of the LEA is measured primarily by the size of the system's cash balance. All other assets and liabilities are recognized only to the extent they have arisen from prior cash transactions. Notes and bonds payable and interfund loans receivable and payable are, therefore, recognized, for example, but accounts receivable and accounts payable are not. Cash-basis accounting provides information about the LEA's financial operations only by reporting changes in the system's cash balance, adjusted for changes in any other assets or liabilities which have arisen through prior cash transactions. One of the greatest weaknesses of the cash basis of accounting is that it does not recognize accounts receivable, accounts payable and other accrued items. It therefore does not match resources used to resources provided. This situation may falsely lead financial statement readers to believe that the statements present the LEA's complete financial position and results of operations. Using the cash basis, an LEA may thus fall into a deficit position without being aware of its real financial position. It is difficult to eliminate a current year deficit if the LEA is not aware of the circumstances until the close of the fiscal year. With cash-basis statements, then, the statement reader may not be able to determine it an LEA is operating beyond its means.