Chapter Four. Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements

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1 Chapter Four Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements Learning Objectives After studying this chapter, you should be able to: 1. Analyze typical operating transactions for governmental activities and prepare appropriate journal entries at both the government-wide and fund levels. 2. Prepare adjusting entries at year-end and a pre-closing trial balance. 3. Prepare closing journal entries and year-end General Fund financial statements. 4. Account for interfund and intra- and inter-activity transactions. 5. Account for transactions of a permanent fund. 6. Distinguish between exchange and nonexchange transactions, and define the classifications used for nonexchange transactions. In Chapter 3, the use of general ledger budgetary control accounts (Estimated Revenues, Estimated Other Financing Sources, Appropriations, Estimated Other Financing Uses, and Encumbrances) and related operating statement accounts (Revenues, Other Financing Sources, Expenditures, and Other Financing Uses) was discussed and illustrated. The necessity for subsidiary ledgers, or equivalent computer files or ledgers, supporting the budgetary control accounts and related operating statement accounts was also discussed. In this chapter, common transactions and events, as well as related recognition and measurement issues, arising from the operating activities of a hypothetical local government, the Town of Brighton, are discussed, and appropriate accounting entries and financial statements are illustrated. 111

2 112 Part One State and Local Governments ILLUSTRATIVE CASE The Town of Brighton s partial government-wide statement of net assets, showing only the governmental activities, and its General Fund balance sheet, both at the end of the 2010 fiscal year, are presented in Illustration 4 1. Because this chapter focuses on governmental operating activities, only the financial information for the Governmental Activities column is presented at this time. The Town of Brighton does have business-type activities, but those activities are discussed in Chapter 7 of the text. Although the Town has no discretely presented component units, the column is shown in the statement of net assets simply to illustrate the recommended financial statement format. Measurement Focus and Basis of Accounting As discussed at several points in the earlier chapters, the government-wide statement of net assets reports financial position using the economic resources measurement focus and the accrual basis of accounting in short, using accounting principles similar to those used by business entities. In contrast, the General Fund balance sheet reports financial position using the current financial resources measurement focus and the modified accrual basis of accounting. Although both of these statements represent financial position at the same point in time, even a casual comparison reveals significant differences. Perhaps the most striking difference between the two statements is that the statement of net assets reports both capital assets and long-term liabilities, whereas the General Fund balance sheet reports only current financial resources and current liabilities to be paid from current financial resources. Current financial resources include cash and items (such as marketable securities and receivables) expected to be converted into cash in the current period or soon enough thereafter to pay current period obligations. Prepaid items and inventories of supplies, if material, are also included in current financial resources. Another major difference is that the information reported in the Governmental Activities column of the statement of net assets includes financial information for all governmental activities, not just for the General Fund. For example, the Town of Brighton also has debt service funds whose cash and receivables are combined with those of the General Fund in the Assets section of the statement of net assets. The investments reported in the statement of net assets belong to the debt service funds. In fact, it will be noted that $77,884 of net assets are restricted for purposes of paying debt service (principal and interest) on long-term debt. (Note: The debt service funds are discussed in Chapter 6.) There are some other less important but still noteworthy differences. One such difference involves format. The Town s statement of net assets is in the GASB-recommended net assets format (that is, assets minus liabilities equals net assets) rather than the traditional balance sheet format (assets equals liabilities plus fund equity). This is not a necessary condition, however, as GASB Statement No. 34 permits governments the option of preparing a government-wide balance sheet rather than a statement of net assets, if they prefer. An alert reader may have noted that the statement of net assets reports financial information in a more condensed manner than does the General Fund balance sheet. The primary reason for reporting more aggregated financial information is that the government-wide financial statements, along with the required management s discussion and analysis (MD&A), are intended to provide a broad overview of the

3 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 113 ILLUSTRATION 4 1 Assets TOWN OF BRIGHTON Statement of Net Assets December 31, 2010 Primary Government Cash $ 257,500 (Omitted Investments 40,384 intentionally) Receivables (net) 619,900 Inventory of supplies 61,500 Capital assets (net) 19,330,018 Total Assets 20,309,302 Liabilities Vouchers payable 320,000 Accrued interest payable 37,500 Due to federal government 90,000 Bonds payable 1,500,000 Total Liabilities 1,947,500 Net Assets Invested in capital assets, net of related debt 17,830,018 Restricted for: Debt service 77,884 Unrestricted 453,900 Total Net Assets $18,361,802 Governmental Business-Type Component Activities Activities Total Units (None) TOWN OF BRIGHTON General Fund Balance Sheet December 31, 2010 Assets Cash $220,000 Taxes receivable delinquent $660,000 Less: Estimated uncollectible delinquent taxes 50, ,000 Interest and penalties receivable on taxes 13,200 Less: Estimated uncollectible interest and penalties 3,300 9,900 Inventory of supplies 61,500 Total Assets $901,400 Liabilities and Fund Balances Liabilities: Vouchers payable $320,000 Due to federal government 90,000 Total Liabilities 410,000 Fund Balances: Reserved for inventory of supplies $ 61,500 Reserved for encumbrances ,000 Fund balance 302,900 Total Fund Balances 491,400 Total Liabilities and Fund Balances $901,400

4 114 Part One State and Local Governments government s financial position. Additional detail is provided in the notes to the financial statements (not provided in this chapter for sake of brevity), as well as in the fund financial statements. In the case of the Town of Brighton, the $453,900 reported for unrestricted net assets in the government-wide statement of net assets is only $37,500 less than the $491,400 reported as the total fund balances of the General Fund. In practice, these amounts may be markedly different, as many governments will have financial information for other governmental fund types that will be reported as part of the governmental activities unrestricted net assets. At any rate, neither the net assets at the government-wide level nor the fund balances (equity) at the fund level are analogous to the stockholders equity of an investor-owned entity. Residents have no legal claim on any net assets or fund equity of the government. A few final points should be noted about the General Fund balance sheet before discussing illustrative budgetary and operating transactions. Fund equity, usually captioned as Fund Balances as shown in Illustration 4 1, is the arithmetic difference between the total financial resources and the total liabilities of the General Fund. The Town of Brighton s General Fund balance sheet illustrates that at December 31, 2010, a portion of fund balances is reserved because the $61,500 inventory of supplies included in the fund s assets cannot be spent or used to pay current liabilities. In addition, some purchase orders issued in fiscal year 2010 were not filled by the end of that year. The estimated $127,000 liability that will arise when these goods or services are received in early 2011 represents a prior budgetary claim on available financial resources, as shown by the line item Reserved for encumbrances 2010 on the General Fund balance sheet presented in Illustration 4 1. The portion of fund balances that is not reserved is shown as a fund balance of $302,900 on the balance sheet. In practice, this item is usually referred to as unreserved fund balance. 1 DUAL-TRACK ACCOUNTING APPROACH Although thousands of governments have adopted the GASBS 34 reporting model, most have continued to use traditional fund accounting software systems. These systems record transactions that occur during the year in the appropriate governmental funds, but they are unable to directly provide account balances on the accrual basis needed for the government-wide financial statements. To compensate for this deficiency, most governments manually convert their fund-based financial information to the accrual basis by preparing spreadsheets, as illustrated in Chapter 9. Most municipal accounting software vendors have helped simplify this approach by developing report generators that selectively aggregate data needed for the governmentwide statements. Nevertheless, the authors believe that the reclassification approach 1 As explained in Chapter 3, Footnote 8, a GASB exposure draft on fund balance reporting proposes to eliminate the reserved and unreserved classifications of fund balance. If the final statement adopts the proposed classification scheme, portions of amounts reported now in the unreserved fund balance classification could be reported in the future as restricted, limited, assigned, or unassigned fund balances, depending on the nature of constraints that may exist on how the fund balances can be spent. When the GASB issues the final statement, the authors will provide an update bulletin explaining how the new standard affects various parts of the text.

5 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 115 is deficient in the sense that the general ledger accounts do not provide all the information needed to prepare government-wide financial statements. Among other problems, the reclassification approach may limit the preparation of governmentwide financial statements to once a year and may present audit trail and accounting record retention problems. In a real-world computerized accounting system, the dual effects of transactions could be captured using an extensive classification coding scheme, augmented by well-designed report writer software, to aggregate information in different ways, for example, by major fund and government-wide. In contrast, this text adopts a dualtrack approach to analyzing and recording transactions based on manual accounting procedures. This approach is designed to facilitate ease of learning; however, as will be apparent in Chapter 9, the dual-track approach also allows preparation of both government-wide and fund financial statements. Operating activities and transactions affect the Town of Brighton s governmentwide financial statements and fund financial statements differently. Certain activities (e.g., those relating to the General Fund budget) have no effect on the government-wide financial statements. Most operating activities or transactions affect both the General Fund and governmental activities at the government-wide level, although differently. Still other activities, such as recording depreciation expense or accruing interest on general long-term debt, affect only the governmentwide financial statements and are not recorded at all in the General Fund or in any other governmental fund. Examples of the latter journal entries are provided in Chapters 6 and 9. ILLUSTRATIVE JOURNAL ENTRIES For the illustrative journal entries that follow, if the account titles or amounts differ in any respect, separate journal entries are illustrated for the General Fund general journal and the governmental activities (government-wide) general journal. For activities or transactions in which the entries would be identical, only a single journal entry is illustrated. In these cases, the heading for the entry indicates that it applies to both journals. Recording the Budget As discussed in Chapter 3, the budget should be recorded in the accounts of each fund for which a budget is legally adopted. For purposes of review, Entry 1, which follows, illustrates an entry to record the budget in the general journal for the General Fund of the Town of Brighton for fiscal year (The entry is shown in combined form to illustrate that format. The detail shown is assumed to be the detail needed to comply with laws applicable to the Town of Brighton. Since the Estimated Revenues, Appropriations, and Estimated Other Financing Uses accounts refer only to the fiscal year 2011 budget and will be closed at the end of the year, it is not necessary to incorporate 2011 in the title of either.) Interfund Transfer to Create a New Fund The town council approved the creation of a new Supplies Fund, an internal service fund, effective January 1, 2011, to provide most operating and office supplies used by departments accounted for in the General Fund. The new fund was created

6 116 Part One State and Local Governments General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund: 1. Estimated Revenues ,986,000 Budgetary Fund Balance ,500 Appropriations ,180,000 Estimated Other Financing Uses ,500 Estimated Revenues Ledger: Property Taxes ,600,000 Interest and Penalties on Delinquent Taxes ,000 Sales Taxes ,000 Licenses and Permits ,000 Fines and Forfeits ,000 Intergovernmental Revenue ,000 Charges for Services ,000 Miscellaneous Revenues ,000 Appropriations Ledger: General Government ,000 Public Safety ,240,000 Public Works ,090,000 Health and Welfare ,000 Parks and Recreation ,000 Miscellaneous Appropriations ,000 Estimated Other Financing Uses Ledger: General Government ,500 by transferring the current inventory of supplies and $30,000 in cash from the General Fund, general government function. Appropriate journal entries are provided in Chapter 7 to create the new internal service fund. The effect on the General Fund is reflected in Entries 2 and 2a below. The transfer has no effect on governmental activities at the government-wide level since financial information for both the General Fund and the new Supplies Fund is reported in the Governmental Activities column. General Fund: 2. Other Financing Uses Interfund Transfers Out ,500 Inventory of Supplies ,500 Cash ,000 Other Financing Uses Ledger: General Government ,500 General Fund: 2a. Reserve for Inventory of Supplies ,500 Fund Balance ,500

7 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 117 Entry 2a is necessary since the General Fund no longer possesses the supplies for which the reservation of fund balance was established (see Illustration 4 1). Although the General Fund will order most operating and office supplies from the new Supplies Fund, certain special-use operating and office supplies will continue to be ordered from external vendors. Encumbrance Entry Interdepartmental requisitions for supplies with an estimated cost of $247,360 were submitted to the Supplies Fund, and purchase orders for certain other supplies and contracts for services were placed with outside vendors in the amount of $59,090. Entry 3 below shows the journal entry required to record the estimated cost of supplies ordered and service contracts. Since some encumbrance documents issued in 2011 may not be filled until early 2012, sound budgetary control dictates that 2011 be added to the Encumbrances general ledger control account and the corresponding Reserve for Encumbrances. The amounts chargeable to specific appropriations of 2011 are debited to detail accounts in the Encumbrances Subsidiary Ledger. (Recall that budgetary entries affect only funds for which a budget is legally adopted; they have no effect at the government-wide level.) General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund: 3. Encumbrances ,450 Reserve for Encumbrances ,450 Encumbrances Ledger: General Government ,000 Public Safety ,000 Public Works ,000 Parks and Recreation ,000 Health and Welfare ,000 Miscellaneous Appropriations When supplies and services ordered during the current year have been received and found to be acceptable, the suppliers or contractors billings or invoices should be checked for agreement with the original interdepartmental requisitions, purchase orders, or contracts as to prices and terms, as well as for clerical accuracy. If all details are in order, the billing documents are approved for payment. If, as is usual practice, the estimated liability for each order was previously recorded in the Encumbrances control account in the general ledger, as well as in subsidiary Encumbrance Ledger accounts, entries must be made to reverse the encumbrances entries for the originally estimated amounts. In addition, entries are required to record the actual charges in the Expenditures control account and subsidiary Expenditures Ledger accounts. Expenses and/or assets must also be recorded in governmental activities accounts at the government-wide level, as appropriate. Assume that goods and services ordered during 2011 by departments financed by the Town of Brighton General Fund (see Entry 3) were received as follows: All supplies ordered at an estimated cost of $247,360 from the internal service fund

8 118 Part One State and Local Governments (Supplies Fund) were received at an actual cost of $249,750; however, only a portion of the supplies and contracts with outside vendors were filled or completed during the year at an actual cost of $19,700, for which the estimated cost had been $22,415. For purposes of illustration, the appropriations assumed to be affected are shown in Entries 4 and 4a for the General Fund. General Fund: 4. Reserve for Encumbrances ,775 General Ledger Encumbrances ,775 Subsidiary Ledger Debits Credits Debits Credits Encumbrances Ledger: General Government ,250 Public Safety ,000 Public Works ,900 Parks and Recreation ,000 Health and Welfare ,175 Miscellaneous Appropriations a. Expenditures ,450 Due to Other Funds ,750 Vouchers Payable ,700 Expenditures Ledger: General Government ,300 Public Safety ,000 Public Works ,600 Parks and Recreation ,000 Health and Welfare ,100 Miscellaneous Appropriations Although the Town of Brighton records the purchase of supplies from the Supplies Fund at the amount billed, the expenses recorded in the governmental activities accounts at the government-wide level should be the cost of the goods to the Supplies Fund. In other words, the cost to the government as a whole is what the internal service fund paid for the goods to external parties, and does not include the markup charged to departments by the Supplies Fund. As shown in Chapter 7, Entries 5a and b, the cost of the $249,750 of supplies issued to the General Fund was $185,000, so the markup is 35 percent on cost. Accordingly, the total direct expenses recorded at the government-wide level (see Entry 4b) is the $185,000 cost of supplies purchased from the Supplies Fund plus the $19,700 of goods and services purchased from external vendors, or a total of $204,700, distributed to functions based on assumed purchase patterns. It is the town s policy to include miscellaneous expenses as part of the General Government function at the government-wide level. (Note that the account credited at the government-wide level for the supplies purchased from the Supplies Fund is Inventory of Supplies since $185,000 represents supplies issued that are no longer in the Supplies Fund s inventory and thus are no longer in inventory from a government-wide perspective, assuming that substantially all supplies purchased by General Fund departments will be consumed during the year. Immaterial amounts of year-end inventory in the General Fund should be ignored.)

9 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 119 General Ledger Subsidiary Ledger Debits Credits Debits Credits Governmental Activities: 4b. Expenses General Government.... 9,885 Expenses Public Safety ,889 Expenses Public Works ,148 Expenses Parks and Recreation ,741 Expenses Health and Welfare ,037 Vouchers Payable ,700 Inventory of Supplies ,000 In addition to supplies, General Fund departments will make expenditures (capital outlays) for equipment or other general capital assets during the year. Although capital outlay expenditures are not illustrated in this chapter, they are recorded in the same manner as were supplies in Entries 3, 4, and 4a. At the government-wide level, an entry similar to Entry 4b would be required, except that the debit would be to Equipment (or other capital asset account as appropriate). Payment of Liabilities Checks were drawn to pay the $339,700 balance of vouchers payable ($320,000 balance at the end of 2010 plus the $19,700 amount from Entry 4a) and the 2010 yearend amount due to the federal government. In addition, the General Fund paid the Supplies Fund $249,750 for supplies purchased in Entry 4a. The following entries would be made for the General Fund and governmental activities at the government-wide level: General Fund: 5a. Vouchers Payable ,700 Due to Other Funds ,750 Due to Federal Government ,000 Cash ,450 Governmental Activities: 5b. Vouchers Payable ,700 Due to Federal Government ,000 Cash ,700 Note that the entry to Due to Other Funds is omitted from Entry 5b as the transfer of cash between a governmental fund and an internal service fund has no effect on the amount of cash available within governmental activities at the governmentwide level. Also, entries to subsidiary appropriation or expenditure accounts in the General Fund are unnecessary since those entries were made previously when the goods and services were received. Some readers may question how more cash can be disbursed in Entries 5a and 5b than is available. This is no cause for concern, as the examples in this chapter are summarized transactions. Throughout the year revenues are also being collected, as illustrated in a later section. Should tax revenues be received later than needed to pay vendors on a timely basis, governments typically issue tax anticipation notes to meet those short-term cash needs, as discussed later in this chapter.

10 120 Part One State and Local Governments Payrolls and Payroll Taxes The gross pay of employees of General Fund departments for the month of January 2011 amounted to $252,000. The town does not use the encumbrance procedure for payrolls. Deductions from gross pay for the period amount to $19,278 for employees share of FICA tax; $25,200, employees federal withholding tax; and $5,040, employees state withholding tax. The first two will, of course, have to be remitted by the town to the federal government, and the last item will have to be remitted to the state government. The gross pay is chargeable to the appropriations in the General Fund as indicated by the Expenditures Ledger debits. Assuming that the liability for net pay is vouchered, the entry in the General Fund is: General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund: 6a. Expenditures ,000 Vouchers Payable ,482 Due to Federal Government ,478 Due to State Government ,040 Expenditures Ledger: General Government ,040 Public Safety ,120 Public Works ,160 Health and Welfare ,080 Parks and Recreation ,600 In addition, the following entry would be required to record the payroll transaction in the governmental activities general journal at the government-wide level, using the accrual basis (expenses rather than expenditures): Governmental Activities: 6b. Expenses General Government ,040 Expenses Public Safety ,120 Expenses Public Works ,160 Expenses Health and Welfare ,080 Expenses Parks and Recreation ,600 Vouchers Payable ,482 Due to Federal Government ,478 Due to State Government ,040 Recording the salaries and wages expenses in the manner shown in Entry 6b permits reporting direct expenses by function, as shown in Illustration A1 2 and as described in Chapter 3 in the discussion on expense classification in the governmentwide statement of activities. If a government prefers to also record the expenses by natural classification (that is, as salaries and wages expense), it will be necessary to add additional classification detail; for example, Expenses General Government Salaries and Wages.

11 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 121 Payment of the vouchers for the net pay results in the following entry in both the General Fund and governmental activities journals: General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund and Governmental Activities: 7. Vouchers Payable ,482 Cash ,482 Inasmuch as the town is liable for the employer s share of FICA taxes ($19,278), it is necessary that the town s liability be recorded, as shown in Entry 8a. General Fund: 8a. Expenditures ,278 Due to Federal Government ,278 Expenditures Ledger: General Government ,681 Public Safety ,943 Public Works ,230 Health and Welfare ,460 Parks and Recreation Entry 8b is also required to record the payroll expense on the accrual basis at the government-wide level. Governmental Activities: 8b. Expenses General Government ,681 Expenses Public Safety ,943 Expenses Public Works ,230 Expenses Health and Welfare ,460 Expenses Parks and Recreation Due to Federal Government ,278 Revenues Recognized as Received in Cash Revenues from sources such as licenses and permits, fines and forfeits, charges for services, and certain other sources are often not measurable until received in cash. However, under the modified accrual basis of accounting, if such revenues are measurable in advance of collection and available for current period expenditure, they should be accrued by recording a debit to a receivable and a credit to Revenues. During fiscal year 2011, the Town of Brighton has collected revenues in cash from the sources shown in Entry 9a.

12 122 Part One State and Local Governments General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund: 9a. Cash ,200 Revenues ,200 Revenues Ledger: Licenses and Permits ,000 Fines and Forfeits ,000 Charges for Services ,000 Miscellaneous Revenues ,200 Of the preceding revenues, licenses and permits, fines and forfeits, and charges for services are appropriately recorded as program revenues at the government-wide level. Licenses and permits are attributed to the general government function. Fines and forfeits were assessed by the Public Safety function in the amount of $91,000 and by the Public Works function in the amount of $60,000. Charges for services were received from customers of the Parks and Recreation function. Miscellaneous revenues cannot be identified with a specific program and thus are recorded as general revenues at the government-wide level. Based on this information the entry that should be made in the journal for governmental activities is shown in Entry 9b. Governmental Activities: 9b. Cash ,200 Program Revenues General Government Charges for Services ,000 Program Revenues Public Safety Charges for Services ,000 Program Revenues Public Works Charges for Services ,000 Program Revenues Parks and Recreation Charges for Services.. 7,000 General Revenues Miscellaneous... 1,200 Readers may be confused by classifying Fines and Forfeits as Charges for Services since generally we associate Charges for Services with exchange or exchange-like transactions in which value is given for value received (see the appendix to this chapter). GASB considered this issue and decided that Charges for Services does not preclude a nonexchange transaction such as Fines and Forfeits. Furthermore, Fines and Forfeits is not appropriately classified as either Operating Grants and Contributions or Capital Grants and Contributions (see program revenue classifications in Illustration A1 2 and Illustration 3 1). Thus, in substance, the GASB decided to classify Fines and Forfeits as Charges for Services to avoid the need to add a fourth category of program revenues in the government-wide statement of activities. 2 2 Governmental Accounting Standards Board, Codification of Governmental Accounting and Financial Reporting Standards, as of June 30, 2008 (Norwalk, CT, 2008), Sec

13 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 123 ACCOUNTING FOR PROPERTY TAXES Entry 1 of this chapter shows that the estimated revenue for fiscal year 2011 from property taxes levied for the Town of Brighton General Fund is $2,600,000. If records of property tax collections in recent years, adjusted for any expected changes in tax collection policy and changes in local economic conditions, indicate that approximately 4 percent of the gross tax levy will never be collected, the gross tax levy must be large enough so that the collectible portion of the levy, 96 percent, equals the needed revenue from this source, $2,600,000. Therefore, the gross levy of property taxes for the General Fund of the Town of Brighton must be $2,708,333 ($2,600, ). In an actual situation, property situated in the Town of Brighton also would be taxed for other funds of that town; for various funds of other general purpose governments, such as the county in which the property in the Town of Brighton is located; the various funds of special purpose governments that have the right to tax the same property, such as one or more independent school districts or a hospital district; and perhaps the state in which the town is located. Recording Property Tax Levy The gross property tax levies for each fund of the Town of Brighton, and for each other general purpose and special purpose government, must be aggregated, and the aggregate levy for that unit divided by the assessed valuation of property within the geographical limits of that government, in order to determine the tax rate applicable to property within each jurisdiction. In many states, a county official prepares bills for all taxes levied on property within the county; the same official, or another, acts as collector of all property taxes levied for the county and all governments within the county. Although the billing and collecting functions may be centralized, the taxes levied for each fund must be recorded as an asset of that fund. If the accounts are to be kept in conformity with generally accepted accounting principles, the portion of the taxes expected to be collectible (0.96 of the total levy, in this example) must be recorded as revenues of that fund, and the portion expected to be uncollectible (0.04 of the total levy), must be recorded in a contra-asset account, as illustrated by Entries 10a and 10b. General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund: 10a. Taxes Receivable Current ,708,333 Estimated Uncollectible Current Taxes ,333 Revenues ,600,000 Revenues Ledger: Property Taxes ,600,000 Governmental Activities: 10b. Taxes Receivable Current ,708,333 Estimated Uncollectible Current Taxes ,333 General Revenues Property Taxes.. 2,600,000

14 124 Part One State and Local Governments As Entry 10a shows, since in the General Fund the general ledger control account, Revenues, is credited, an entry must also be made in the Revenues Subsidiary Ledger. Taxes Receivable Current is also a control account, just as is the Accounts Receivable account of a business entity; each is supported by a subsidiary ledger that shows how much is owed by each taxpayer or customer. Ordinarily, the subsidiary ledger supporting the real property taxes receivable control is organized by parcels of property according to their legal descriptions, since unpaid taxes are liens against the property regardless of changes in ownership. Because of its conceptual similarity to accounting for business receivables, taxes receivable subsidiary ledger accounting is not illustrated in this text. Property tax revenue is an example of a nonexchange revenue one in which the government receives value without directly giving equal value in exchange. More specifically, it is classified under GASB standards as an imposed nonexchange revenue. For imposed nonexchange revenues, a receivable should be debited when there is an enforceable claim, as in the case of a property tax levy, and a revenue should be credited in the year for which the tax was levied. The $2,600,000 credit to Revenues in Entry 10a indicates that the Town of Brighton expects to collect that amount during 2011 or within 60 days after the end of fiscal year If the town expected to collect a portion of the $2,600,000 later than 60 days after fiscal yearend, it should credit that portion to Deferred Revenues (a current liability account) and reclassify it to Revenues in the period in which the deferred revenues are collected. Note, however, that even if a portion of revenues is deferred in the General Fund because of the availability criterion, the full $2,600,000 is recognized as General Revenues Property Taxes in the governmental activities journal at the government-wide level. This is so because availability to finance current expenditures is not a revenue recognition criterion under the accrual basis used at the governmentwide level. Collection of Current Taxes Collections of property taxes levied in 2011 for the General Fund of the Town of Brighton amount to $2,042,033. Since the revenue was recognized at the time of the levy (see Entry 10a), the following entry is made in both the General Fund and governmental activities journal. General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund and Governmental Activities: 11. Cash ,042,033 Taxes Receivable Current ,042,033 Reclassification of Current Property Taxes Assuming that all property taxes levied by the Town of Brighton in 2011 were legally due before the end of the year, any balance of taxes receivable at year-end is properly classified as delinquent taxes rather than current. The related allowance for estimated uncollectible taxes should also be reclassified as contra to the Taxes 3 GASB Codification, Sec. P

15 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 125 Receivable Delinquent account. The entry to accomplish the reclassification, using amounts assumed to exist in the accounts at year-end, is: General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund and Governmental Activities: 12. Taxes Receivable Delinquent ,300 Estimated Uncollectible Current Taxes ,333 Taxes Receivable Current ,300 Estimated Uncollectible Delinquent Taxes 108,333 Accrual of Interest and Penalties on Delinquent Taxes Delinquent taxes are subject to interest and penalties as discussed previously. If the amount of interest and penalties earned in 2011 by the General Fund of the Town of Brighton but not yet recognized is $13,320, and it is expected that only $10,800 of that can be collected, the following entries are necessary: General Funds: 13a. Interest and Penalties Receivable on Taxes ,320 Estimated Uncollectible Interest and Penalties ,520 Revenues ,800 Revenues Ledger: Interest and Penalties on Delinquent Taxes ,800 Governmental Activities: 13b. Interest and Penalties Receivable on Taxes. 13,320 Estimated Uncollectible Interest and Penalties ,520 General Revenues Interest and Penalties on Delinquent Taxes ,800 Collection of Delinquent Taxes Delinquent taxes are subject to interest and penalties that must be paid at the time the tax bill is paid. It is possible for a government to record the amount of penalties at the time the taxes become delinquent. Interest may be computed and recorded periodically to keep the account on the accrual basis; it must also be computed and recorded for the period from the date of last recording to the date when a taxpayer pays delinquent taxes. Assume that taxpayers of the Town of Brighton have paid delinquent taxes totaling $440,000, on which interest and penalties of $8,800 had been recorded as receivable at the end of Also, assume that additional interest of $600 was paid for the period from the first day of 2011 to the dates on which the delinquent taxes were paid. Since it is common for the cashier receiving the collections to be permitted to originate source documents that result in credits only to Taxes Receivable Current, Taxes Receivable Delinquent, or Interest and Penalties Receivable on Taxes, the $600 interest earned in 2011 should be recorded in a separate entry, as shown in Entries 14a and b.

16 126 Part One State and Local Governments General Funds: 14a. Interest and Penalties Receivable on Taxes General Ledger Revenues Revenues Ledger: Subsidiary Ledger Debits Credits Debits Credits Interest and Penalties on Delinquent Taxes The corresponding entry at the government-wide level is: Governmental Activities: 14b. Interest and Penalties Receivable on Taxes General Revenues Interest and Penalties on Delinquent Taxes Collection of the delinquent taxes as well as interest and penalties thereon is summarized in Entry 15, which is the entry that should be made in both the General Fund and governmental activities journals. Note that these collections during 2011 are from the delinquent taxes receivable reported on the 2010 General Fund balance sheet and the Governmental Activities column of the government-wide statement of net assets (see Illustration 4 1). General Fund and Governmental Activities: 15. Cash ,400 Taxes Receivable Delinquent ,000 Interest and Penalties Receivable on Taxes ,400 Write-off of Uncollectible Delinquent Taxes Just as officers of profit-seeking entities should review aged schedules of receivables periodically to determine the adequacy of allowance accounts and authorize the write-off of items judged uncollectible, so should officers of a government review aged trial balances of taxes receivable and other receivables. Although the levy of property taxes creates a lien against the underlying property in the amount of the tax, accumulated taxes may exceed the market value of the property, or, in the case of personal property, the property may have been removed from the jurisdiction of the government. When delinquent taxes are deemed uncollectible, the related interest and penalties must also be written off. If the treasurer of the Town of Brighton receives approval to write off delinquent taxes totaling $26,300 and related interest

17 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 127 and penalties of $1,315, the entry for both the General Fund and governmental activities would be: General Fund and Governmental Activities: 16. Estimated Uncollectible Delinquent Taxes ,300 Estimated Uncollectible Interest and Penalties ,315 General Ledger Taxes Receivable Delinquent ,300 Interest and Penalties Receivable on Taxes ,315 Subsidiary Ledger Debits Credits Debits Credits When delinquent taxes are written off, the tax bills are retained in the files in case it becomes possible to collect the amounts in the future. If collections of written-off taxes are made, it is highly desirable to return the tax bills to general ledger control by making an entry that is the reverse of the write-off entry, so that the procedures described in connection with Entries 14 and 15 can be followed. Tax Anticipation Notes Payable In the December 31, 2010, Statement of Net Assets and General Fund Balance Sheet of the Town of Brighton, two items, Vouchers Payable and Due to Federal Government, are current liabilities. Assuming there was a need to pay these in full within 30 days after the date of the balance sheet, the town treasurer would need to do some cash forecasting because the balance of Cash in the General Fund is not large enough to pay the $410,000 debt. In addition to this immediate problem, the treasurer, and most governmental treasurers, faces the problem that cash disbursements during a fiscal year tend to be approximately level month by month, whereas cash receipts from major revenue sources are concentrated in just a few months. For example, property tax collections may be concentrated in two separate months, such as May and November, when the installments are due. Receipts from the state or federal government of revenues collected by superior jurisdictions for distribution to a local government are also often concentrated in one or two months of the year. Knowing these relationships, the treasurer of the Town of Brighton may, for example, forecast the need to disburse approximately one-fourth of the budgeted appropriations, or $1,045,000 (one-fourth of $4,180,000), during the first three months of fiscal year 2011, before major items of revenue are received. This amount plus current liabilities at the beginning of the year, $410,000, plus a $30,000 interfund transfer to create the new Supplies Fund, equals $1,485,000 expected cash disbursements in the period for which the forecast is made. The town s experience suggests that a conservative forecast of collections of delinquent taxes and interest and penalties thereon during the forecast period will amount to $425,000. Furthermore, assume the treasurer s review of the items in the Estimated Revenues budget indicates that at least $140,000 will be collected in the forecast period. Therefore, total cash available to meet the estimated $1,485,000 of disbursements is $785,000 ($220,000 cash as of the beginning of the period, plus the $425,000 and $140,000 items just described), leaving a deficiency of $700,000 to be met by borrowing. Determination of the $700,000 required tax anticipation note financing is summarized in Illustration 4 2.

18 128 Part One State and Local Governments ILLUSTRATION 4-2 Determination of Required Tax Anticipation Note Financing, January 1 through March 31, 2011 Estimated Expenditure Requirements: Budgeted expenditures (25% of $4,180,000), $1,045,000 Current liabilities payable 440,000 $1,485,000 Estimated Resources Available: Cash available at January 1, ,000 Collections of delinquent taxes, interest, and penalties 425,000 Collection of budgeted FY 2011 revenues 140, ,000 Estimated Amount of Required Tax $ 700,000 Anticipation Note Financing The taxing power of the government is ample security for short-term debt; local banks customarily meet the working capital needs of a government by accepting a tax anticipation note from the government. Additional discussion of cash budgeting is provided in Chapter 13. If the amount of $700,000 is borrowed at this time, the necessary entries in both the General Fund and governmental activities are: General Ledger Subsidiary Ledger Debits Credits Debits Credits General Fund and Governmental Activities: 17. Cash ,000 Tax Anticipation Notes Payable ,000 Repayment of Tax Anticipation Notes As tax collections begin to exceed current disbursements, it becomes possible for the Town of Brighton to repay the local bank for the money borrowed on tax anticipation notes. Just as borrowing the money did not involve the recognition of revenue, the repayment of the principal extinguishes the debt of the General Fund and is not an expenditure. Payment of interest, however, must be recognized as the expenditure of an appropriation because it requires a reduction in the fund balance of the fund. Assuming the interest is $13,500, and the amount is properly chargeable to Miscellaneous Appropriations, the entry is: General Fund: 18a. Tax Anticipation Notes Payable ,000 Expenditures ,500 Cash ,500 Expenditures Ledger: Miscellaneous Appropriations ,500 Procedures of some governments would require the interest expenditures to have been recorded as an encumbrance against Miscellaneous Appropriations at the time the notes were issued, and the liability for the principal and interest to have been vouchered before payment. Even if these procedures were followed by the Town of Brighton, the net result of all entries is achieved by Entry 18a.

19 Chapter 4 Accounting for Governmental Operating Activities Illustrative Transactions and Financial Statements 129 A similar entry, shown as Entry 18b, is made at the government-wide level except that an expense rather than expenditure is recorded for the interest charged on the note. This expense is deemed to be an indirect expense that benefits no single function. General Ledger Subsidiary Ledger Debits Credits Debits Credits Governmental Activities: 18b. Tax Anticipation Notes Payable ,000 Expenses Interest on Tax Anticipation Notes.. 13,500 Cash ,500 Other Taxes In addition to property taxes, many state and local governments receive sales and use taxes, income taxes, motor fuel taxes, and various other kinds of taxes, including those on businesses. These taxes, like property taxes, are nonexchange transactions in which one party (taxpayers in this case) does not receive (give) value proportionate to the value given (received). However, these taxes derive their valuation from underlying exchange transactions, such as selling goods, earning wages and salaries, and purchasing fuel. Thus, the GASB refers to taxes such as sales and income taxes as derived tax revenues. Generally, derived tax revenues should be recognized in the period in which the underlying exchange has occurred. In practice, collections of sales and income taxes may not occur in the same period in which the underlying sales or earning transactions occurred. For example, local governments often experience delays in collecting sales taxes because in most states these taxes are collected by state governments. Moreover, businesses may only be required to file a sales tax return and remit taxes on a monthly basis. Income taxes are subject to even less frequent filings and collections. Consequently, at the end of a fiscal period, governments generally will need to estimate the amount of sales or income taxes that have accrued but have not yet been reported. Such entries will require a debit to a taxes receivable account and a credit to the Revenues control account and the appropriate Revenues Subsidiary Ledger accounts. INTERIM FINANCIAL REPORTING Unlike publicly traded corporations, state and local governments usually are not required to provide quarterly or other interim financial statements to external parties. Although there is no requirement for external interim reporting, all state and local governments should prepare interim financial schedules for the internal use of administrators and legislators. The frequency and nature of interim reports are at the discretion of each government. At a minimum, quarterly budgetary comparison schedules should be prepared showing actual revenues to date compared with budgeted revenues and actual expenditures and outstanding encumbrances to date compared with appropriations. Schedules such as these for the Town of Brighton, prepared as of the end of the first quarter of the 2011 fiscal year, are presented as Illustrations 4 3 and 4 4. (Note: The amounts of revenues, expenditures, and

20 130 Part One State and Local Governments ILLUSTRATION 4 3 TOWN OF BRIGHTON General Fund Schedule of Budgeted and Actual Revenues For the Three Months Ended March 31, 2011 Estimated Revenues Sources of Revenues Estimated Actual Not Yet Realized Taxes: Property taxes $2,600,000 $2,599,636 $ 364 Interest and penalties on taxes 13, ,400 Sales taxes 480, ,000 Total taxes 3,093,000 2,600, ,764 Licenses and permits 220, , ,000 Fines and forfeits 308, , ,000 Intergovernmental revenue 280, ,000 Charges for services 70,000 7,000 63,000 Miscellaneous revenues 15,000 1,200 13,800 Total General Fund Revenue $3,986,000 $2,859,436 $1,126,564 encumbrances shown in these schedules are the amounts assumed to exist through March 31, 2011.) Such schedules are essential to sound budgetary control and often include an additional column showing prior year revenues and expenditures/encumbrances for the same period. So that appropriate officials can take timely action to correct unexpected revenue or expenditure/encumbrance variances, it may be necessary to prepare interim budgetary comparison schedules on a monthly, or even weekly, basis, rather than quarterly. This is particularly true for larger governments. ILLUSTRATION 4 4 TOWN OF BRIGHTON General Fund Schedule of Budgeted and Actual Expenditures and Encumbrances For the Three Months Ended March 31, 2011 Expenditures of 2011 Outstanding Available Function Appropriations Appropriations Encumbrances Appropriations General government $ 660,000 $ 129,100 $15,750 $ 515,150 Public safety 1,240, , ,600 Public works 1,090, ,060 9, ,840 Health and welfare 860,000 67,700 5, ,475 Parks and recreation 315,000 72,000 6, ,000 Miscellaneous appropriations 15, ,550 Total General Fund $4,180,000 $1,191,710 $36,675 $2,951,615

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