Chapter Two

Principles of Accounting and Financial

Reporting for State and Local Governments
(SLGs)
 Activities of Government
•There are three major activity categories of a
state and local governments – Governmental
Activities, Business-Type Activities, and
Fiduciary Activities.
 Governmental Activities
As per GASB Concepts Statement No.1, government provides
certain core services called General Activities.
• General Activities provided by most general purpose
governments are related to:
 Protection of life and property, police and fire protection,
 Public works (streets and highways, bridges, and public
building),
 Parks and recreation facilities and programs,
 Cultural and social services
•Governments also incur costs for general administrative support
such as data processing, finance, and personnel.
• Core governmental services, together with general administrative
support, comprise the major part of Governmental Activities
 
 Business-type Activities
Governments also engage in business type
activities. These include:
Public utilities (electric, water, and gas utilities)
Transportation system;
Toll roads;
Airports;
Hospitals;
Many of these activities are intended to be self
supporting by charging users for the services
they receive.
 Fiduciary Activities
•Governments often act in a fiduciary capacity,
either as an agent or trustee, for parties outside the
government.
•A government may serve as agent for other
governments in the administering and collecting of
taxes.
•Governments serve also as trustees for amounts
placed in trust from private citizens for different
purposes, for escheat properties (that revert to the
government when there are no legal claimants or
heirs to a deceased individual’s estate), and for
assets being held for employee pension plans.
 Cont’d
•Accounting and financial reporting principles for the
Business-Type Activities of governments are quite
similar to those for commercial business entities.
•Accounting and reporting for the Fiduciary
Activities of the government use principles similar to
those of business type activities. Certain fiduciary
activities, those related to defined benefit pension
plans and similar post-employment health care plans
use unique recognition standards prescribed by
GASB.
 
 Cont’d
• To achieve operational accountability
reporting for the government as a whole,
required highly aggregated financial
statements (called Government-Wide
Financial Statements) that report both
Governmental Activities and Business-Type
Activities.
GASB Statement of Principles of
Accounting and FR for SLGs
•At its inception in 1984, the GASB adopted 12
accounting and financial reporting principles for
state and local governments.
•A separate principle has been articulated for
long-term liabilities, bringing the total now to 13
principles as follows:
 Cont’d
1.Principle of Accounting and Reporting
Capabilities
2.Principle of Fund Accounting Systems
3.Principle of Types of Funds
4.Principle of Number of Funds
5.Principle of Reporting Capital Assets
6.Principle of Valuation of Capital Assets
 Cont’d
7. Principle of Depreciation of Capital Assets
8. Principle of Reporting Long-Term Liabilities
9. Principle of Measurement Focus and Basis of
Accounting
10. Principle of Budgeting, Budgetary Control, and
Budgetary Reporting
11. Principle of Transfer, Revenue, Expenditure, and
Expense Account Classification
12. Principle of Common Terminology and
Classification
13. Principle of Annual Financial Reports
Each of the above principle is explained in subsequent
sections.
Principle No. 1: Accounting and Reporting
Capabilities
A governmental accounting system must make it
possible both:
(a) to present the funds and activities of the
government in conformity with generally
accepted accounting principles, and
(b) to determine and demonstrate compliance
with finance related legal and contractual
provisions.
 
 Cont’d
•Governmental units may prepare two sets of
financial statements:
(a) one set in compliance with GAAP (General
purpose financial statements) and
(b) one set in compliance with legal
requirements (Special Reports).
Principle No. 2: 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 self-balancing set of accounts
reporting financial resources, together with all
related liabilities and residual equities.  
 Cont’d
•The term Fund refers to fiscal and accounting
entity that is used to account for resources that are
segregated for achieving certain objectives.
• Fiscal Entity refers to any entity that is concerned
with some assets set a side for a specific purpose,
and Accounting Entity refers to anything that uses
a double entry accounting entity to balance the
resources with claims to resources.
 
 
 Cont’d
Justification for using fund and fund accounting
 To control and segregate resources that are
externally restricted and internally designated.
 To ensure and demonstrate compliance with legal
and administrative requirements
Principle No. 3: Types of Funds
•State and local governments, should use 11 fund
types as needed.
•These fund types are organized into three
categories; governmental funds, proprietary funds,
and fiduciary funds. Principle No. 3 discusses these
fund types. However, funds should be used by state
and local governments to the extent that they have
activities that meet the criteria for using those
funds.
 
 Cont’d
A) Governmental Funds: - account for
activities of a government that are carried out
primarily to provide services to citizens and
that are financed primarily through taxes.
Governmental Funds are classified into five:
General Fund, special revenue funds, capital
projects funds, debt service funds, permanent
funds, which are discussed as follows:
 Cont’d
1. The General Fund (GF)
It is used to account for resources required to
provide most of the basic services provided by
the governmental unit such as public safety,
public works, education, etc.
– account for all financial resources except those
required to be accounted for in another fund.
 Cont’d
2. Special Revenue Funds (SRFs) – to account
for proceeds from specific revenue sources that
are legally restricted to use for specified
purposes. The purpose of special revenue fund
is to demonstrate that all revenues from that
source are used for the special purpose only.
for example, a government earmarked 25% of
current year revenue from value added tax for
draught affected people
 Cont’d
3. Capital Project Funds (CPFs) – accounts for
financial resources to be used for the
acquisition or construction of major capital
project facilities (other than those financed by
proprietary funds or fiduciary funds).
They are used to account for financial resources
segregated to pay for construction or acquisition
of long-lived capital assets such as the
construction of bridge, buildings, road, dams,
railway, hydroelectric power etc.
 Cont’d
4. Debt Service Funds (DSFs) – are used to
account for the accumulation of resources for the
payment of, general long-term debt principal and
interest. It monitors the financial resources
currently available to satisfy long-term liabilities
and also records the eventual payments.
 Cont’d
5. Permanent Funds (PFs) – to account for
legally restricted resources provided by trust in
which the earnings but not the principal may be
used for purposes that support the primary
government’s programs (those that benefit the
government or its citizenry)
(Note: similar permanent trusts that benefit
private individuals, organizations, or other
governments that is, private purpose trust funds
are classified as fiduciary funds).
 Cont’d
B) Proprietary Funds – account for a government’s
ongoing organizations and activities that are similar
to those operated by for- profit organizations. This
fund type normally encompasses operations where a
user charge is assessed so that determining operating
income or cost-recovery is important.
For example: a Toll Road would be reported within
the proprietary funds. Two types of funds used by
state and local governments are classified as
proprietary funds.
 Cont’d
1) Enterprise Funds (EFs) – 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
of providing goods or services to the general
public be recovered primarily through user
changes; or
b) where the governing body have decided that
periodic determination of revenues earned, is
appropriate for capital maintenance, management
control, accountability or other purposes.
 Cont’d
2. Internal Service Funds (ISFs) – to account
for the financing of goods or services provided
by one department or agency to other
departments or governmental units, on a cost
reimbursement basis.
 Cont’d
Examples of activities that can be accounted through
enterprises funds include:
 Centralized vehicle maintenance or Garage facility
(Fleet services fund)
 Photo Copy service activities (copy service fund)
 Providing several type of insurance programs
(Insurance revolving fund)
 Centralized supply stores (Warehouse revolving
fund).
 Cont’d
C) Fiduciary Funds – these are trust and
agency funds that are used to account for
assets held by a governmental unit in a
trustee capacity or as an agent for
individuals, private organizations, and other
governmental unit.
For these funds the government is acting as a
collecting/disbursing agent or as a trustee.
These include:
 Cont’d
1. Agency Funds- are used to account for situations in
which the government is acting as a
collecting/disbursing agent.
An example would be a State tax agency fund, where
the State collects property taxes for other taxing unit,
such as Federal Government.
2. Pension (and Other Employee Benefit) Trusts
Funds- are used to account for pension and employee
benefit funds for which the governmental unit is the
trustee.
 Cont’d
4. Investment Trust Funds – account for external
investment pools in which the assets are held for other
(external) governments, along with funds of the
sponsoring government.
5. Private Purpose Trust Funds- report all other trust
arrangements under which principal and income benefit
individuals, private organization or other governments.
• 
 Principle No. 4: 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 because unnecessary funds result in
inflexibility, undue complexity, and inefficient
financial administration.
 Principle No. 5: Reporting Capital Assets

•A clear distinction should be made between

general capital assets and capital assets of
proprietary and fiduciary funds.
•Capital assets of proprietary funds should be
reported in both government wide and fund
financial statements.
• Capital Assets of fiduciary funds should be
reported in only the statement of fiduciary net
assets.
 
 Cont’d
•All other capital assets of the governmental unit
are general capital assets. They should be
reported in the Government-Wide Statement of
Net Assets.
•General capital assets include land, buildings,
improvements other than buildings, and
equipment used by activities accounted for by
the fund types classified as governmental funds.
 Principle No. 6: Valuation of Capital Assets

•Capital assets be should reported at historical

cost. The cost of a capital asset should include
capitalized interest and additional charges
necessary to replace the asset into its intended
location and condition for use.
•Donated capital assets should be reported at
their estimated fair value at the time of the
acquisition plus ancillary changes if any.
 
 Principle No. 7: Depreciation of Capital Assets

•Capital assets should be depreciated over their

estimated lives unless they are either
inexhaustible or are infrastructure assets
according to the modified approach of GASB
Statement No. 34.
•Inexhaustible assets such as land, historical
heritage or antiquities, and fine arts should not
be depreciated.
 Cont’d
•Infrastructure assets are long-lived assets that
normally are stationary in nature and normally
can be preserved for a significantly greater
number of years than most capital assets.
Examples of infrastructure assets are roads,
bridges, tunnels, drainage systems, water and
sewer systems, dams, and lighting systems.
 Principle No. 8: Reporting Long-Term Liabilities

A clear distinction should be made between fund

long-term liabilities and general long - term
liabilities.
• Long term liabilities directly related to and
expected to be paid from proprietary funds
should be reported in the proprietary fund
statement of net assets.
 
 Cont’d
• Long-term liabilities directly related to and
expected to be paid from fiduciary funds
should be reported in the statement of
fiduciary net assets.
• All other un matured general long-term
liabilities of the governmental unit should be
reported in the government wide statement of
net assets.
 Principle No. 9: Measurement Focus and Basis of
Accounting
Measurement Focus
explains the items measured, and reported to prepare
basic financial statements and determine
accountability for the entrusted resources. There are
two types of Measurement Focuses:
1.Economic Resources Measurement Focus
•It measures inflows and outflows of economic
resources (current and noncurrent). It is also called All
Resources Measurement Focus. It mainly focuses on
operational accountability; whether management
efficiently uses resources in providing services
 Cont’d
2. Current Financial Resources Measurement
Focus
•It measures inflows and outflows of current
resources (expandable resources i.e., cash or
other items expected to be converted into cash
during the current period). It mainly focuses on
fiscal accountability; whether managers have
met budgetary and other legal financial
requirements
 Basis of Accounting (Accounting Method)

It gives answer to the question when should revenues and

expenses or expenditures be recognized?
1. Accrual Basis of Accounting
Accrual Accounting means that (1) revenues should be recorded
in the period in which the service is given, although payment is
received in a prior or subsequent period, and (2) expense should
be recorded in the period in which the benefit is received,
although payment is made in a prior or subsequent period.
2. Modified Accrual Basis of Accounting
Under modified accrual basis of accounting, Revenues, should be
recognized in the accounting period in which they become
available and measurable.
Measurable means capable of being expressed in monetary
terms; available is defined as “collectible within the current
period.
 Cont’d
3. Cash Basis of Accounting
•Under Cash Basis of Accounting; (1) revenues
should be recorded in the period in which cash is
received, although payment is received in a prior or
subsequent period, and (2) expense should be
recorded in the period in which cash is paid, although
service is received in a prior or subsequent period.
A) Government-Wide Financial Statements
•The government wide statement of net Assets and
statement of activities should be prepared using the
economic measurement focus and the accrual basis
of accounting.  
•   Cont’d
B) Fund Financial statement
In Fund financial statements, the modified accrual
or accrual basis of accounting, as appropriate,
should be used in measuring financial position and
operating results.
(1) Governmental funds should be presented
using the current financial resources
measurement focus and the modified accrual
basis of accounting.
(2)Proprietary fund statements should be
presented using the economic resources
measurement focus and the accrual basis of
 Cont’d
3) Fiduciary funds should be reported using the
economic resources measurement focus and the
accrual basis of accounting except for the
recognition of certain post employment health
care plans
4) Transfers (between funds) should be reported
when inter fund receivables and payable arise.
Principle No. 10: 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 budgetary control.
c. Budgetary comparison schedules should be
presented as required supplementary
information (RSI) for the general fund and
each major special revenue fund that has a
legally adopted annual budget.  
 Principle No. 11: Transfers, Revenue, Expenditure and Expense Account Classification

a.Transfers should be classified separately from

revenues and expenditures or expenses in the
basic financial statements.
b. Proceeds of general long-term debt issued
should be classified separately from revenues
and expenditures in the governmental fund
financial statements.
c. Governmental fund revenues should be
classified by fund and source. Expenditures
should be classified by fund.
 Cont’d
d) Proprietary fund revenues should be
reported by major sources, and expenses should
be classified in essentially the same manner as
business organization, functions, or activities.
e) The statement of activities should present
governmental activities
 Principle No. 12: 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.
 Principle No. 13: Annual Financial Reports

a) A Compressive Annual Financial

Report (CAFR) should be prepared and
published, covering all activities of the primary
government including introductory sections,
management’s discussion and analysis (MD & A),
basic financial statements, required supplementary
information other than MD & A, combining and
fund financial statements scheduled, narrative
explanations, and statistical section.
 
 Cont’d
b) The minimum requirements for MD & A,
basic financial statements and required
supplementary information other than MD & A
are:
1.Management’s discussion and analysis
2.Basic financial statements. The basic financial
statements should include:
 Government – Wide Financial Statements
 Fund Financial Statements
 Notes to the Financial Statements
3. Required supplementary information other than
MD & A.
Governmental Financial Reporting Entity

•In government accounting and reporting, the

financial reporting entity must be identified. The
financial reporting entity consists of primary
government and component units.
• 
 Cont’d
Primary Government
•includes any state government or general purpose local
government such as a city or county. It also includes a
special purpose local government such as a school system
also may be deemed a primary government if it meets three
criteria:
 It has a separately elected governing body.
 It is legally independent
 It is fiscally independent of other state and local
governments.
Component Units
• organizations for which the primary government is
financially accountable
Common Accounting Characteristic of Fund Types
1. Common Accounting Characteristics Governmental
Funds
 Focus on fiscal accountability
 Measure and report current (expendable) financial resources
 Use modified accrual basis of accounting
 Account for and report revenues and expenditures
 No capital assets or long-term liabilities accounted for in
funds; no depreciation reported in funds
 Budgetary accounts integrated into the funds to achieve
legal budgetary control
 Required Financial Statements:
 Balance Sheet
 Statement of revenues, expenditures, and changes in fund
balances
 Cont’d
2. Common Accounting Characteristics Proprietary Funds
 Focus on operational accountability
 Measure and report economic resources (as in business
accounting)
 Use full accrual basis of accounting
 Account for and report revenues and expenses
 Account for capital assets or long-term liabilities within
the funds; report depreciation
 Budgetary accounts not integrated into the funds; should
use budgeting for planning and control purposes
 Required Financial Statements:
 Statement of net assets
 Statement of revenues, expenses, and changes in net assets
 Statement of cash flows
 Cont’d
3. Common Accounting Characteristics Fiduciary
Funds
 Accounting for fiduciary funds is similar to that for
proprietary funds, i.e., full accrual accounting and
focus on flows of economic resources
 Capital assets and long-term liabilities are recorded in
the funds, if applicable
 Additions (to net assets) and deductions (from net
assets) are recorded instead of revenues and expenses
 Required Financial Statements:
Statement of fiduciary net assets; and
Statement of changes in fiduciary net assets
 .

End of This Chapter