Main Content

Lesson 2: Priniciples of Accounting for State and Local Governments

Fund Accounting

fund letters on stacks of coins

© iStock/Thinkstock

Before we talk about funds, we first need to discuss the concept of an entity. A reporting entity defines the boundaries of a particular financial reporting unit by describing whose assets, liabilities, revenues, expenses, and equities are included in the entity’s financial report. In the private sector, if a parent company, such as General Motors, exercises control over its legally separate subsidiaries, the financial activities of all those units are consolidated for financial reporting purposes.

In state and local governmental accounting, there is also the complexity of the dimension of the reporting entity. For example, a city's financial report may cover not only the activities of the legally constituted government, but also the separate legal organizations for which the city is financially responsible. The "city" is referred to as the primary government; the separate legal organizations are called component units. The primary government itself is disaggregated, subdivided into separate fiscal and accounting entities, called funds.

Definition of a Fund

From GASB, the formal legal definition of a fund by is as follows:

…a fiscal and accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equities or balances, and changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations. (GASB Codification of Governmental Accounting and Financial Reporting Standards, 2010)

In this definition, the term fiscal entity refers to the separate budgetary nature of funds that have only spendable financial resources. The term accounting entity refers to a separate financial unit that is treated as an entity for accounting purposes. Some types of funds also have capital assets that, in fund accounting terms, are non-spendable, non-financial resources.

Governmental organizations must comply with legal requirements stated in constitutions, city charters, statutes, local ordinances, etc. Because the organizations' day-to-day activities are guided by budgets proposed by the executive branch and enacted into law by the legislative branch, internal accounting systems are needed to ensure compliance with budgetary spending limits. Funds have traditionally provided a basic control mechanism for ensuring compliance with legal restrictions on the use of governmental resources. Most funds are set up because of specific legal requirements.

Fund accounting is probably the most distinctive feature of governmental and not-for-profit organization accounting. Fund accounting segregates an organization’s assets, liabilities, and net assets into separate accounting units based on legal restrictions, donor-imposed regulations, or special regulations. Fund accounting is a convenient control mechanism to help ensure that resources are spent for the intended purpose. Because each fund is a separate accounting element, each must have a set of self-balancing accounts; that is, the total of the assets of a particular fund must equal the total of its liabilities and fund balance (or net assets). Thus, the accounting records of a particular fund must identify the fund's unique resources and the claims to those resources, as differentiated from all other funds.

Organizations that use fund accounting generally establish a separate general fund or unrestricted current fund, where resources can be used for any purpose designated by the governing body. In addition, they use separate unique accounts for the acquisition and disposition of restricted-use resources (generally by law, regulation, or donor requirement).

Fund Categories

To better understand the unique aspects of state and local government accounting, it is important to examine the types of activities that government conducts, how the activities are financed, and how governments are organized to carry activities out. It is also important to identify the role of laws and budgets in governmental accounting and reporting. State constitutions and statutes and local laws determine what governments do, how their activities are financed, and how their activities are organized. Most governmental activities carried out on a daily basis are based upon budget appropriations that, once enacted, have the force of law. Government accounting systems are designed not only in terms of stewardship of resources, but also in terms of accountability for resources entrusted to government and to help ensure budgetary compliance with appropriations. There are several ways to categorize governmental activities. One way is to differentiate the activities by purpose and how the activities are financed: (1) governmental, (2) proprietary (business), and (3) fiduciary.

State and local governments account for their basic services in the governmental funds category. Governmental funds account for the accumulation and spending of resources, primarily taxes and grants, that provide the public with day-to-day services, such as police, fire, education, sanitation, parks, and highway maintenance. Governmental funds are also used to account for resources legally earmarked for a particular governmental purpose and for the acquisition or construction of general governmental capital assets, such as roadways, maintenance depots, police stations, and firehouses. For example, a separate governmental fund may be used to account for the proceeds of debt sold to construct a new firehouse. Another fund may be used to accumulate resources to pay the debt service on those bonds.
A proprietary (business) fund is a category that is used to account for "business-type" governmental activities that operate similarly to private sector businesses in that the government charges fees for their services and measure whether their revenues will cover their expenses. Examples of such activities are municipal hospitals, electric and water utilities, mass transit facilities, and central motor pools. Many of these activities are self-supporting because their fees are sufficient to cover their costs. Others, such as mass transit facilities, may receive subsidies from their parent government and some, such as lotteries, provide net revenues for the parent. When these business-type activities are performed by agencies within the government, a separate proprietary fund is established. When the activities are performed by legally separate entities, these entities use what is called proprietary fund accounting.
Fiduciary funds are used by governments to account for resources they hold in trust or in an agency capacity for others. "Others" might be individuals or other governments or private organizations. Because these funds are held for others, the resources in these funds cannot be used to support the government’s own programs. Examples of situations in which a government might act in a trust or an agency capacity include assets held on behalf of employees participating in governmental pension or post-employment healthcare plans, investment pools operated by a sponsoring government on behalf of other governments, and sales taxes collected by a state on behalf of county and city governments.

Criteria for Determining Major Funds

GASB Statement 34 requires two financial statements for the general fund and other governmental funds. Both statements report separate columns for major funds and for non-major funds, as well as a totals column. These statements are the Balance Sheet and the Statement of Revenues, Expenses, and Changes in Fund Balances. (Note: you will see specific examples through the City and County of Denver, Examples 4-2 and 4-3 in Lesson 4.)

There are three circumstances under which a fund is considered major and is shown in its own column in the financial statements:

  1. The main operating fund (usually the general fund) is always considered a major fund.
  2. An individual governmental or enterprise fund’s assets, liabilities, revenues, OR expenditures/expenses are at least
    1. 10% of the total for all governmental OR enterprise funds, respectively, AND
    2. 5% of the total for all governmental AND enterprise funds COMBINED.
  3. Government may designate as major any other governmental or enterprise fund it believes is important to the users of its financial statements.

A government may designate any fund as major if reporting that fund separately in the basic statements would be deemed useful. In all fund statements, the non-major funds are aggregated and reported in a single column. Fiduciary fund financial statements and the internal service fund portion of proprietary fund statements are reported by fund type, not major fund.

References
  • GASB Codification of Governmental Accounting and Financial Reporting Standards (GASB Cod.). Sec. 1300, "Statement of Principle-Fund Accounting Systems" (Norwalk, CT: GASB, 2010).

Top of page