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					                    Chapter 9
            Business-Type (Proprietary)

Chapter 9              Granof-5e          1
      Thought to Ponder: Chapter 9
"Nobody wants a landfill sited anywhere near
    them, including in rural areas. We've come to
    this realization that landfill is valuable and we
    can't bury things that don't need to be buried."
                     - JON D. JOHNSTON      of the EPA,
    who is helping to lead the zero-waste movement in
    the Southeast.
                                      NY TIMES-Oct. 20, 2009

Chapter 9                 Granof-5e                            2
                 Learning Objectives
 Why governments and NFPs engage in business-
  type activities
 Distinguish between Proprietary and
  Governmental activities
 Proprietary Fund Accounting
 Two types of Proprietary Funds
     --Enterprise Funds
     --Internal Service Funds
 Accounting for Insurance Activities
 GASB 34, special problems of reporting
  proprietary funds in government-wide statements

Chapter 9                       Granof-5e           3
              Proprietary Funds
 Reasons for use:
  to account for governmental entity’s ongoing
    (continuing) operations and activities
  Enhances management of activities in which
    goods or services are provided on a cost-
    reimbursement basis (i.e. on a user charge
  To compare benefits and costs of the
    business-type activities of a government.
  Facilitates comparisons with private
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                       Proprietary Funds
Two types Proprietary Funds
A) Enterprise funds:
    Provide services to the general public.
    Example: City of Houston’s Airports (Bush, Hobby
     and Ellington Field), George R. Brown Convention
     Center, Combined Utility System (formerly called the
     water and sewer system), etc.
B) Internal service funds:
    Provide services to other government departments.
    Example: City of Houston Health Benefit and Long-
     term Disability funds.
          Both of these services predominantly benefit governmental
           units rather than the general public or businesses

  Chapter 9                        Granof-5e                           5
Proprietary Funds -Accounting Characteristics
  GASB Statement No. 20, Accounting and Financial
   Reporting for Proprietary Funds and Other
   Governmental Entities That Use Proprietary Fund
      Funds are said to be nonexpendable (or revolving)
      focus on determining operating net income, changes in
       net assets (or cost recovery).
      Full accrual basis
      Measurement focus on all economic resources is
       consistent with GASB
      Recognize revenues as earned and expenses as incurred.
      Balance sheet recognition to both capital assets and long-
       term debt.

   Chapter 9                   Granof-5e                            6
                   Proprietary Funds
              Required Financial Statements
Similar to those for a for-profit entity:
     Statement of Net Assets (or Balance Sheet):
        Assets – Liabilities = Net Assets
            --Three categories of Net Assets
                1) Invested in capital assets, net of related debt
                2) Restricted Net assets
                3) Unrestricted Net Assets

     Statement of Revenues, Expenses, and changes in Fund Net Assets:
        --Reconciles beginning and ending net assets
     Statement of Cash Flows
        --Prepared in conformity with GASB standards rather than FASB standards
        --Include cash and cash equivalents (i.e., time deposits, marketable securities,
            and other items readily convertible to cash)

Chapter 9                                     Granof-5e                              7
      Proprietary Funds - Accounting Equation
            Assets - Liabilities = Net Assets

1) Unrestricted 2) Restricted Assets 3) Invested in
    Assets      (e.g., for payment of Capital Assets, Net
                     debt service)    of Related Debt

Recall this is the same classification of net
 assets that is required under GASB 34.

Chapter 9                  Granof-5e                        8
                       2) Restricted Assets
       Definition: Assets whose use is restricted by contractual
        agreements or legal requirements
       Typical examples:
             Customer deposits of utilities, assets set aside for repayment of
              revenue bond principal, reserves for maintenance of plant, and
              funding of depreciation
       Ideally liabilities to be paid from restricted assets should
        be reported separately from liabilities to be paid from
        unrestricted assets.
       Net Assets – Restricted, should be reported in the Equity
        section of the Statement of Net Assets.

Chapter 9                            Granof-5e                                9
                 Statement of Cash Flows
Required for proprietary funds but not governmental funds

FASB (NFPs & publicly-traded companies)
GASB (Governmental entities):

FASB Statement No. 95 classifies cash transactions into:
     Cash flows from operating activities
     Cash flows from financing activities
     Cash flows from investing activities

GASB Statement No. 9:
       Cash flows from operating activities
       Cash flows from NON-CAPITAL financing activities
       Cash flows from CAPITAL & RELATED financing activities
       Cash flows from investing activities

  Chapter 9                          Granof-5e                   10
                     Enterprise Funds
 Accounts for services:
1) provided to the general public on a user charge basis OR
2) where the governing body has determined that periodic
   determination of revenues earned, expenses incurred,
   and/or net income is appropriate.
 Possible reasons for use:
    --Capital maintenance, Public policy, Management
      control, Accountability
Examples: The City of Atlanta has two major and four non-major
   enterprise funds. The City of New York has no enterprise funds, but
   has a large number of specially created public benefit corporations. On
   the other hand, High Point, North Carolina has six enterprise funds,
   and City of San Francisco has eight enterprise funds.

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     Common Types of Enterprise Funds
 –   Water and sewer (public utilities)
 –   Gas and electric utilities
 –   Mass Transportation systems
 –   Airports (ex. Bush, Hobby, Ellington Field)
 –   Ports
 –   Toll roads and bridges (Sam Houston Tollway – Beltway 8, Harris
 –   Parking garages and lots (ex. Theater District parking garage)
 –   Golf courses (Hermann Park)
 –   Landfill facilities
 –   Hospitals
 –   Liquor stores
 –   Lotteries

Chapter 9                     Granof-5e                         12
                Accounting for Enterprise Funds
    GASB Statement No. 34 provides guidance on business-type activities.

     MUST use enterprise funds if one of the following criteria is met:
        1) Activity financed solely with revenue debt instead of governmental obligation
        2) Costs of providing services recovered by fees and charges
        3) Pricing policy are designed to recover costs from fees and charges

     Previously, GASB standards allowed proprietary funds two options:
             1) Follow pronouncements of the FASB and its predecessors issued before
              November 30, 1989, unless they conflict with a GASB standard  *
             2) Follow all FASB and predecessor standards, both those issued before and after
              November 30, 1989, unless they conflict with a GASB standard   *
                 * Note that GASB standards always take priority

Chapter 9                                   Granof-5e                                      13
                           Enterprise Funds
               Utility Plant - Construction in Progress
Q: Should an imputed amount equivalent to
   interest be capitalized if a utility’s own
   funds are used for construction?
A: Capitalizing an ―equity‖ component of
   Allowance for Funds Used During
   Construction (AFUDC) is permitted both
   by utility regulators and the FASB.

   Chapter 9                     Granof-5e                14
                Municipal Solid Waste Landfills
            Accounted for either in governmental or enterprise funds
              If usage fees are charged then accounted for in enterprise funds.

           Fees must cover ALL costs (i.e. costs incurred before, during, and after
            landfill accepts waste)
               Closure & Post-closure costs include:
                    Equipment installed and facilities constructed after the landfill stops
                      accepting waste (e.g. gas monitoring systems, ground water
                      monitoring wells.)
                    Final Cover
                    Monitoring & Maintenance

       If accounted for in ENTERPRISE FUND:
             Governments must report (but need not actually fund) both :
               Expense &
               Liability related to Closure & Post-Closure costs.
       If accounted for in GOVERNMENTAL FUND:
                   Liability/Expense of post closure costs reported only in government-
                    wide statements.
                   No expenditure shown in Fund Statements
                     --“Pay-as-you-go” basis
Chapter 9                                  Granof-5e                                      15
             Municipal Solid Waste Landfills
     An EPA rule requires all municipal landfills to meet stringent location,
      design, and operating requirements to minimize the potential for
      environmental damage.

     Operators must also provide financial assurance they can properly close
      landfills when full and provide post-closure ground water monitoring for 30
      years after closure.

     These stringent rules are designed to protect the environment from
      irresponsible handling of hazardous materials

         Owners must estimate the current cost of hiring a qualified third-party
          to close the MSWLF and care for it for 30 years after closure

         Current Year Liability/Expense =
                (Estimated total cost x Landfill capacity)
                ________________________________ - Amount recognized in the past
                      Total Landfill Capacity

         Annual adjustments are made as estimates change from year to year.

Chapter 9                               Granof-5e                                   16
Government can be held accountable for pollution
 cleanup costs owing to a variety of
 circumstances. For example:
•   A school district discovered mold or asbestos in one of its buildings
•   Toxic substances from an abandoned county dump seeped into a nearby water supply

As with landfill costs, pollution remediation costs may be accounted for in either
   governmental or enterprise funds.
• Governmental funds: only current outlays would be recognized as
   expenditures; no long-term liabilities would be recorded.
• Enterprise funds as well as government-wide stmts: estimates of costs to be
   incurred in the future would be reported as both expenses and offsetting

    Chapter 9                         Granof-5e                                 17
Per GASB Statement No. 49 Accounting and Financial Reporting for
  Pollution Remediation Obligations (November 2006), the pollution
  remediation costs to be accounted for include those for:

   Pre-cleanup activities such as site assessments, site investigations,
   Cleanup activities such as removal and disposal of pollutants
   Government oversight and enforcement-related activities
   Post-remediation monitoring

These costs should be estimated and recognized as an expense and
  liability when the government knows or has reason to believe that a
  site is polluted, that it will be responsible for the cleanup, and it can
  make reasonable estimates of the ultimate cost.

    Chapter 9                      Granof-5e                             18
                      Enterprise Funds
                  Special Current Liabilities
In addition to the usual Accounts Payable and Accrued
   Expenses, use two special current liability accounts:
    1) Customers Advances for Construction
              Usually up-front deposits required to be made by
               builders to provide all or part of the cost of
               connecting new structures to utility lines. May or
               may not be refunded in part upon completion
    2) Customer Deposits
              Usually reported under the caption ―Liabilities
               Payable from Restricted Assets‖

 Chapter 9                      Granof-5e                           19
                Enterprise Funds
     Regulatory Accounting Principles (RAP)
  FASB Statement No. 71 Accounting for the Effects
    of Certain Types of Regulation issued in 1982, stipulated
        that revenues, expenses and resources should be recognized in
        accordance with the rules established by a regulator.

  Key RAP definitions
             Original cost: The (depreciated) cost to the first owner
              to place the utility plant into public use
             Utility Plant Acquisition Adjustment: The difference
              between the purchase price of a utility plant less the
              net original cost of the plant on the seller’s books.

Chapter 9                         Granof-5e                             20
  Enterprise Funds Segment Information
            When there are multiple enterprise funds
                 Summary operating data, including
                  extent of intra- governmental subsidies,
                  should be disclosed in the notes for
                  "major non-homogeneous enterprise

Chapter 9                Granof-5e                           21
                  Internal Service Funds
Internal Service funds are an accounting device used to
   accumulate and allocate costs internally among the
   governmental entity’s various departments/units/functions.
Account for activities:
    -- that provide goods or services to other funds,
       departments, or agencies within the same governmental
       unit or occasionally to other governmental units on a
       user-charge or cost-reimbursement basis
Primary reason for use:
   --to gain efficiency in the government’s operations.
Examples: The City of Houston has two internal service funds; San
     Francisco has four internal service funds (central shops fund, finance,
     corporation reproduction fund, telecommunications and information
     fund) whereas the City of New York has no internal service funds.

Chapter 9                          Granof-5e                               22
     Common Types of Internal Service Funds

         Motor pools
         Central purchasing
         Storage
         Issuance of supplies
         Self-insurance pools
         Central data processing
         Printing

Chapter 9                        Granof-5e    23
Chapter 9   Granof-5e   24
Chapter 9   Granof-5e   25
          Accounting for Internal Service Funds
Internal Service Funds . . .
     . . . are accounting entities
     . . . are authorized by legislative approval
     . . . rarely have its resources restricted

 Must follow all FASB pronouncements issued prior to
  Nov. 30th 1989 unless it conflicts with GASB
  pronouncement (like enterprise fund).
 The GFOA recommends that every state or local
  government establish clear criteria for whether an
  internal fund is classified as a fund in the CAFR.
  Chapter 9                     Granof-5e              26
   Accounting for Internal Service Funds (cont.)
     Full Accrual Basis
         --Revenues derived mainly from other governmental or proprietary funds.
         --―Billings to Departments‖ is the revenue account that is similar to ―Sales‖ of a for-
         --Capital assets acquired by contributions or grants must be depreciated.
     Revenues & expenses are closed at year-end to ―Excess of Net Billings
      to Departments over Costs‖ (or ―Excess of Costs over Net Billings to
      Departments‖) rather than to Income Summary
     Since the only ―customer‖ of the internal service fund is the
      government itself, the activity is presented in fund financial
      statements, but eliminated for external facing reporting.
     The major fund requirements do not apply to internal service
      funds because their balances are eliminated in the
      government-wide financial statements
  Chapter 9                               Granof-5e                                       27
    Pricing Policies for Internal Service Funds

             Pricing is set by local management or
              by legislative policy
             Pricing objectives vary
               --Can cover full costs (direct and
                 indirect), direct costs only, or
                 whatever management desires.
               --Full cost prices do not reflect cost of
                 providing incremental amounts of
                 goods or services.

Chapter 9                 Granof-5e                    28
             Question Number One (1)
Q: Assume that one of the government’s internal service funds was for
   data processing services, for which the golf course was billed $30,000,
   all of which was classified as ―contractual services‖ in the golf course
   fund. How would that amount be reported in the column for ISF? How
   would it be reported in the government-wide financial statements?

A: Fund Statements: Billings of ISF would be reported as a revenue of
   ISF and as an expense of the golf course. The related cost of providing
   the service would be reported as an expense of the ISF.

    Government-wide: Billings would be reported ONLY as an expense
    of the golf course. The revenues and expenses of the ISF would be
    eliminated in the consolidation process.

Chapter 9                        Granof-5e                               29
            Pregunta Número Dos (2)
   Q: ISF reported $2.7 million in depreciation, an
        amount that the government takes into account in
        establishing the rates charged to other funds. How
        would this charge be reflected in the government-
        wide statements?

   A: The depreciation charges are incorporated into the
      amounts billed to the funds to which the ISF
      provide services. Therefore, in the government-
      wide, they would be incorporated into the expenses
      of the functions accounted for in those funds.

Chapter 9                     Granof-5e                      30
            вопрос, номер три (3)
Q: In which column on the government-wide
  statement of net assets—that for governmental
  or business-type activities—is it most likely that
  the assets and liabilities of the ISF would be

A: Unless the ISF provides services mainly to
  units accounted for in proprietary funds, their
  assets and liabilities would be reported in the
  column for governmental-type activities.
Chapter 9               Granof-5e                      31
                         问题第四 (4)

     Legislative bodies are sometimes reluctant to
     establish ISFs because they do not wish to let
     purchasing occur outside the budget.

Q: Is this (budget) a real concern?

A: Even if an ISF is created for central purchasing and
   sales of supplies, the legislative body still maintains
   budgetary control over the expenditures made by
   most departments and programs via the General
   Fund and special revenues funds budgets.

Chapter 9                       Granof-5e                    32
 Some governments elect to self-insure their risks.
   --Reduces premiums
 Self insurance = NO INSURANCE (no transfer of risks to
   --It simply sets aside funds to provide for possible losses based on an
       actuarially determined amount.
    --Often a govt. that self-insures part (or all) of its risk also centralizes
       its risk financing activities
    --Either use the GF or the ISF to account for these activities
Example: City of Juneau, Alaska has a self-insurance fund to account for
   the cost of administering the City and Borough’s Risk Management

Chapter 9                           Granof-5e                                  33
                         Self - Insurance
GASB-mandated use of an ISF
     GASB standards require that an ISF be used for risk management (self-
      insurance) pools of a government:
           --The ISF should recognize claims expense and a related liability
              1) It is probable an asset has been impaired, a liability incurred,
                or a claim will be asserted AND
              2) Loss is estimable
              Disclose other loss contingencies in the notes.

     Insurance department acts as an independent insurance company.
     Premium Payments by government to ISF:
        Only a portion is reported as expenditure by the government (and
          revenue by the ISF).
        Excess is a nonreciprocal transfer.

Chapter 9                           Granof-5e                                34
                     PROBLEMS with ISFs

      Duplicate reported expenses when closing books
            -costs and revenues are reported twice within the same set of
              financial statements.

      Depreciation is transferred to other governmental funds
      Detract from Objectivity of Financial Statements
      Obscure Fund Balance Surpluses or Deficits
            -surpluses/deficits can be transferred from general fund to the
              internal service fund.

Chapter 9                             Granof-5e                               35
       Terminating an Internal Service
        Transfer ISF's assets to another fund which will
         continue same activity
        Terminate activity and distribute assets in-kind to
         another fund or funds
        Convert ISF's assets to cash and distribute cash
         to another fund or funds

Chapter 9                     Granof-5e                        36
               Component Units (CU)
•   The main reason for discussing CU in Ch. 9 is that some cities will
    carry out these activities as CU and some will do it as part of EFs. The
    main difference is the legal structure. CU are separate legal entities.

•   Entities that are economically intertwined with the government albeit
    legally separate
•   Criteria to determine whether a primary government (PG) is financially
    accountable for another government.
          (1) PG appoints a voting majority of unit’s governing body
          (2) A majority of unit’s governing body is composed of PG’s officials
          (3) The PG is able to “impose its will” upon the unit
          (4) Unit can cause the PG financial benefits or burdens
•   If it meets these criterion, then unit is a CU of PG.
•   Two Presentations of CU
          (1) Blended – CU consolidated with PG in government-wide
            • Presented this way if CU “provides services exclusively or
              almost exclusively for the city” (City of Houston CAFR)
          (2) Discrete – CU shown in a separate column in government-wide
Chapter 9                           Granof-5e                                37
               Business –Type Activities
         Proprietary funds (internal service and enterprise) are
          used to account for the business-type activities of a
         Accrual accounting is used for proprietary funds and
          the required financial statements are the same as those
          for a for-profit entity, except that GASB standards
          must be used where they apply
         ISF are reported as governmental activities on the
          government-wide statements
         Regulatory accounting terminology and principles are
          used by some government owned utilities.

Chapter 9                      Granof-5e                        38

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