Governmental Accounting
Introduction
Governmental accounting applies to state and local governments, including cities, counties, school districts, and special-purpose entities. Some hospitals and universities that are government-run also follow governmental accounting standards. The primary standard-setter is the Governmental Accounting Standards Board (GASB). :::info Key Concept
The fundamental purpose of governmental accounting is to demonstrate accountability — showing that public resources are used in compliance with laws, regulations, and budgetary authority. This contrasts with for-profit accounting, which focuses on profitability.
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Fund Accounting
Governments use fund accounting to segregate resources for specific purposes. A fund is a self-balancing set of accounts used to track resources dedicated to a particular activity or objective. Fund accounting serves three purposes:
- Monitoring compliance with legal and contractual requirements
- Tracking spending by purpose
- Budgetary control over appropriations
Three Categories of Funds
:::tip CPA Exam Tip
Memorize the fund mnemonics: GRaSPP (Governmental), SE (Proprietary), and CIPPOE (Fiduciary). The exam frequently tests which fund category a transaction belongs to.
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Governmental Funds (GRaSPP)
Governmental funds use the modified accrual basis of accounting and the current financial resources measurement focus. They report only current assets and current liabilities — no long-term assets or long-term debt.
| Fund | Purpose |
|---|---|
| General Fund | Accounts for all resources not required to be in another fund; the "catch-all" fund |
| Special Revenue Fund | Accounts for resources legally restricted or committed for specific purposes (e.g., gas tax for roads) |
| Debt Service Fund | Accounts for accumulation of resources for payment of general long-term debt principal and interest |
| Capital Projects Fund | Accounts for resources used to acquire or construct major capital facilities |
| Permanent Fund | Accounts for resources that are legally restricted so that only earnings (not principal) may be used for government programs |
Modified Accrual Basis
Under modified accrual:
- Revenues are recognized when they are measurable and available
- Available means collectible within the current period or soon enough thereafter to pay current liabilities (typically 60 days after year-end)
- Expenditures (not expenses) are recognized when the fund liability is incurred, except for certain items like debt service (recognized when due/mature)
warning
Governmental funds report expenditures, not expenses. An expenditure is recognized when a liability is incurred. There is no depreciation in governmental funds because capital assets are not reported at the fund level.
Revenue Recognition Example
Kingfisher Industries, a city government, levies $5,000,000 in property taxes. Of this amount, $4,800,000 is expected to be collected within 60 days of year-end, and $150,000 is expected to be collected between 61 and 120 days. The remaining $50,000 is estimated uncollectible.
When the deferred portion is collected within the availability period of the next year:
Budgetary Accounting
Governments are legally required to adopt budgets for governmental funds (especially the General Fund). Budget entries are recorded at the beginning of the fiscal year and reversed at year-end.
Recording the Budget
Bear Co. City Council adopts an annual budget with estimated revenues of $10,000,000 and appropriations (authorized spending) of $9,500,000.
- Estimated revenues is a budgetary debit account (not real revenue)
- Appropriations is a budgetary credit account (authorized spending limit)
- Budgetary fund balance is the plug — a credit indicates an expected surplus; a debit indicates an expected deficit
Closing the Budget at Year-End
The entry is reversed at year-end:
Encumbrance Accounting
Governments use encumbrances to track outstanding purchase orders and commitments. This prevents overspending appropriations.
Step 1: Record the Encumbrance (Purchase Order Issued)
Gies Co. School District orders $200,000 of textbooks:
Step 2: Reverse Encumbrance and Record Expenditure (Goods Received)
The textbooks arrive with an invoice for $195,000:
:::tip CPA Exam Tip
Encumbrances are always reversed at the estimated amount, not the actual amount. The expenditure is recorded at the actual amount. Any difference flows through the available fund balance.
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Outstanding Encumbrances at Year-End
If purchase orders are still outstanding at year-end, the encumbrances may be:
- Closed and re-established the following year, or
- Left open as a reservation of fund balance Either way, outstanding encumbrances are reported as part of restricted, committed, or assigned fund balance — never as expenditures or liabilities.
Proprietary Funds (SE)
Proprietary funds operate like businesses within government. They use the full accrual basis of accounting and the economic resources measurement focus.
| Fund | Purpose |
|---|---|
| Internal Service Fund | Provides goods/services to other departments within the government (e.g., motor pool, IT, printing) |
| Enterprise Fund | Provides goods/services to the general public on a user-charge basis (e.g., water, sewer, electric utilities, airports) |
Proprietary Fund Financial Statements
- Statement of Net Position (balance sheet)
- Statement of Revenues, Expenses, and Changes in Net Position (income statement)
- Statement of Cash Flows (uses direct method — required, not optional)
warning
Unlike for-profit entities, proprietary fund cash flow statements must use the direct method. Also, proprietary funds classify cash flows into four categories: operating, noncapital financing, capital financing, and investing.
Enterprise Fund Example
Illini Security, a government-run utility, bills customers $3,000,000 for water services:
The utility purchases a new water treatment facility for $8,000,000:
Annual depreciation of $400,000:
Fiduciary Funds (CIPPOE)
Fiduciary funds account for resources held by the government in a trust or custodial capacity for others. They use the full accrual basis of accounting.
| Fund | Purpose |
|---|---|
| Custodial Fund | Resources held temporarily for other entities (tax collection for other governments) |
| Investment Trust Fund | External portion of investment pools managed by the government |
| Private Purpose Trust | Trust arrangements where principal and income benefit external parties |
| Pension Trust Fund | Resources held for employee pension plans |
| Other Employee Benefits Trust | Resources held for OPEB and similar plans |
Fiduciary fund resources belong to others, not the government. They are excluded from the government-wide financial statements.
GASB 34 Reporting Model
GASB Statement No. 34 established the minimum reporting requirements for state and local governments:
Government-Wide Financial Statements
Report the government as a whole using the full accrual basis and economic resources measurement focus:
| Statement | Content |
|---|---|
| Statement of Net Position | All assets, deferred outflows, liabilities, deferred inflows, and net position |
| Statement of Activities | Expenses by function, program revenues, general revenues, and change in net position |
| The Statement of Activities uses a net cost format: |
Program revenues include: charges for services, operating grants, and capital grants.
Fund-Based Financial Statements
Report individual funds using the measurement focus and basis appropriate to each fund type:
- Governmental funds: Modified accrual; report current financial resources
- Proprietary funds: Full accrual; report economic resources
- Fiduciary funds: Full accrual; report economic resources
Reconciliation
A reconciliation is required between fund-based governmental fund statements and the government-wide statements. Major differences include:
| Item | Governmental Funds | Government-Wide |
|---|---|---|
| Capital assets | Not reported (expenditure when purchased) | Capitalized and depreciated |
| Long-term debt | Not reported | Reported as liability |
| Accrued interest | Not reported until due | Accrued |
| Internal service funds | Separate reporting | Blended into governmental activities |
Fund Balance Classifications (GASB 54)
Governmental fund balance is classified into five categories (most to least constrained):
| Classification | Constraint Level | Set By |
|---|---|---|
| Nonspendable | Cannot be spent (inventory, prepaid, permanent fund principal) | Nature of the resource |
| Restricted | Externally imposed or by law | Creditors, grantors, laws |
| Committed | Self-imposed by highest decision-making authority | Government's governing body |
| Assigned | Intended use set by authorized body/official | Governing body or designee |
| Unassigned | Residual; only in General Fund (may be negative in other funds) | N/A |
| :::tip CPA Exam Tip |
Remember the order: N-R-C-A-U (Nonspendable, Restricted, Committed, Assigned, Unassigned). The spending order is generally from most restricted to least restricted unless the government has a different policy.
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Measurement Focus Comparison
| Feature | Modified Accrual (Governmental) | Full Accrual (Proprietary / Gov-Wide) |
|---|---|---|
| Revenue recognition | Measurable and available | Earned |
| Expense/expenditure | When liability is incurred (current) | When incurred (all) |
| Capital assets | Not reported | Capitalized and depreciated |
| Long-term debt | Not reported | Reported |
| Focus | Current financial resources | Economic resources |
Summary
| Topic | Key Rule |
|---|---|
| Standard-setter | GASB |
| Fund types | Governmental (GRaSPP), Proprietary (SE), Fiduciary (CIPPOE) |
| Governmental basis | Modified accrual, current financial resources |
| Proprietary basis | Full accrual, economic resources |
| Available period | Within 60 days of year-end |
| Budget entry accounts | Estimated Revenues, Appropriations, Budgetary Fund Balance |
| Encumbrances | Reversed at estimated amount; actual recorded as expenditure |
| Government-wide statements | Full accrual for all activities |
| Fiduciary funds | Excluded from government-wide statements |
| Cash flow method (proprietary) | Direct method required |
:::warning Final Exam Reminder
The CPA exam heavily tests the differences between modified accrual and full accrual. Make sure you can convert governmental fund statements to government-wide statements by adding back capital assets, long-term debt, and accrued items.
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