Expenditures and Expenses
Understanding the distinction between expenditures and expenses is fundamental to governmental accounting. Governmental funds use the modified accrual basis and report expenditures — measures of current financial resources consumed. Government-wide statements and proprietary funds use the accrual basis and report expenses — measures of economic resources consumed. Mastering when and how each is recognized is essential for the CPA exam.
This section maps to BAR Area III, Group C, Topic 7 – Expenditures and Expenses. Representative tasks:
- Calculate expenditures to be recognized under the modified accrual basis of accounting (paid from available fund financial resources) for state and local governments and prepare journal entries.
- Calculate expenses to be recognized under the accrual basis of accounting for state and local governments and prepare journal entries.
Expenditures vs. Expenses — Fundamental Distinction
| Expenditures | Expenses | |
|---|---|---|
| Used in | Governmental fund statements (modified accrual) | Government-wide & proprietary fund statements (accrual) |
| Measurement focus | Current financial resources | Economic resources |
| Recognition | When a fund liability is incurred and payable from current resources | When the economic benefit is consumed |
| Capital assets | Entire cost recorded when acquired | Depreciation/amortization over useful life |
| Long-term debt principal | Recorded as expenditure when due | Not an expense (reduction of liability) |
A quick test: if the question says "governmental fund" or "General Fund," think expenditures (modified accrual). If it says "government-wide," "proprietary fund," or "Statement of Activities," think expenses (full accrual).
Modified Accrual Basis — Governmental Funds
Under the modified accrual basis, expenditures are generally recognized when the related fund liability is incurred, provided the liability will be paid from currently available financial resources. The key exceptions involve items not normally expected to be liquidated with expendable available resources.
General Recognition Rule
Classification by Character
| Character | Description | Examples |
|---|---|---|
| Current | Day-to-day operating costs | Salaries, supplies, contractual services |
| Capital outlay | Acquisition of capital assets | Equipment, buildings, vehicles |
| Debt service | Principal and interest on long-term debt | Bond principal payments, interest payments |
| Intergovernmental | Payments to other governments | Grants to subrecipients, shared revenues |
Classification by Function
| Function | Examples |
|---|---|
| General government | Legislative, executive, finance |
| Public safety | Police, fire, corrections |
| Public works | Streets, sanitation, utilities |
| Health and welfare | Social services, health department |
| Culture and recreation | Parks, libraries, museums |
| Education | School districts (if applicable) |
Specific Recognition Rules
Supplies — Purchase Method vs. Consumption Method
Governments may account for supplies (inventory) under either method:
| Method | At Purchase | At Consumption | Year-End Reporting |
|---|---|---|---|
| Purchase method | Debit Expenditures | No entry | Nonspendable fund balance for remaining inventory |
| Consumption method | Debit Inventory | Debit Expenditures, Credit Inventory | Inventory on balance sheet; nonspendable fund balance |
Example — Purchase Method: Bear City buys $60,000 of supplies. At year-end, $8,000 remains on hand.
Year-end adjustment to report nonspendable fund balance:
Example — Consumption Method: Same facts.
At purchase:
At year-end (record consumption of $52,000):
Under both methods, the fund balance sheet reports inventory as an asset with an offsetting nonspendable fund balance. The difference is when the expenditure hits the operating statement — at purchase or at consumption.
Prepaid Items
Prepaid items follow the same two methods as supplies. Under the purchase method, the full amount is expended when paid. Under the consumption method, the prepaid asset is reduced as benefits are consumed.
Debt Service Expenditures
Principal and interest on general long-term debt are recognized as expenditures in the debt service fund when they are due (maturity date):
Interest on long-term debt is recognized as an expenditure when legally due — not when accrued over time. This is a major difference from accrual accounting. However, if resources have been accumulated in a debt service fund for payment early in the next year, governments may accrue the expenditure at year-end.
Compensated Absences
Under modified accrual, compensated absences (vacation, sick leave) are recognized as expenditures only to the extent they are expected to be liquidated with expendable available financial resources — typically the amount that employees have used but not yet been paid for at year-end. The long-term portion is reported only in the government-wide statements.
Accrual Basis — Government-Wide and Proprietary Funds
Under full accrual, expenses are recognized when the economic benefit is consumed, regardless of when cash is paid.
| Item | Expenditure (Modified Accrual) | Expense (Full Accrual) |
|---|---|---|
| Capital asset purchased for $500,000, 10-year life | $500,000 in year of purchase | $50,000/year depreciation |
| Bond principal payment of $200,000 | $200,000 when due | Not an expense (reduces liability) |
| Supplies purchased $80,000; used $65,000 | $80,000 (purchase method) or $65,000 (consumption method) | $65,000 |
| Compensated absences earned $120,000; paid $90,000 | $90,000 (amount currently due) | $120,000 (full amount earned) |
Capital Asset Depreciation
In government-wide statements, capital assets are depreciated:
Governmental fund statements never report depreciation. Depreciation only appears in government-wide and proprietary fund statements.
Compensated Absences (Full Accrual)
Conversion from Fund Statements to Government-Wide Statements
When preparing government-wide statements, governments must convert governmental fund expenditures to accrual-basis expenses. Key adjustments:
Conversion Example
Bear City's General Fund reports the following expenditures:
| Item | Fund Expenditure |
|---|---|
| Salaries | $2,000,000 |
| Supplies (purchase method) | $300,000 |
| Capital outlay (equipment) | $400,000 |
| Debt service – principal | $250,000 |
| Debt service – interest | $100,000 |
| Total expenditures | $3,050,000 |
Additional information for conversion:
- Supplies on hand at year-end: $45,000 (beginning inventory was $30,000)
- Equipment has a 10-year life, no salvage; full-year depreciation on existing assets = $180,000
- Accrued interest payable increased by $15,000 during the year
- Compensated absences earned but not yet due: $60,000
Conversion to government-wide expenses:
| Adjustment | Amount |
|---|---|
| Fund expenditures | $3,050,000 |
| Remove capital outlay | (400,000) |
| Add depreciation | +180,000 |
| Remove debt principal | (250,000) |
| Adjust supplies: reduce by inventory increase ($45,000 – $30,000) | (15,000) |
| Adjust interest: add accrued increase | +15,000 |
| Add compensated absences earned | +60,000 |
| Government-wide expenses | $2,640,000 |
Journal Entries — Proprietary Fund (Full Accrual)
Proprietary funds (enterprise and internal service) use full accrual, recording expenses like a business:
Purchase of equipment ($400,000, 10-year life):
Annual depreciation:
Record utility revenue earned and wages expense:
Summary Comparison Table
| Transaction | Governmental Fund (Modified Accrual) | Government-Wide (Full Accrual) |
|---|---|---|
| Buy equipment $100,000 | Expenditure $100,000 | Capitalize asset; depreciate |
| Pay bond principal $50,000 | Expenditure $50,000 | Reduce Bonds Payable |
| Pay bond interest $20,000 | Expenditure $20,000 (when due) | Expense (accrued over time) |
| Employees earn leave $30,000 | Expenditure only for current portion | Expense full $30,000 |
| Buy supplies $10,000; use $7,000 | Expenditure $10,000 (purchase) or $7,000 (consumption) | Expense $7,000 |
| Record depreciation | Not applicable | Expense each period |
When you see a conversion or reconciliation question, remember the mnemonic "DCALIPS": Depreciation added, Capital outlay removed, Accrued liabilities adjusted, Long-term debt principal removed, Interest accrued, Prepaids and Supplies adjusted.