Chapter 3Basis of Accounting Neither GASB nor FASB have control over budgeting principles Budgeting principles are directly set by either the government/organization or the government/organization

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Granof, et al. – 7th edition Chapter 3 |

Chapter 3Issues of Budgeting and Controls

© 2016 John Wiley & Sons, Inc. All rights reserved. 1


Thoughts to Ponder: Chapter 3“A budget is more than simply numbers on a page. It is a measure of how well we are living up to our obligations to ourselves and one another.”

- President Barack Obama

“Every family in America knows they have to do a budget. Every small business in America knows they have to do a budget. Every local government, every state, knows they have to do a budget.”

- Speaker John Boehner


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Learning Objectives•Key Purposes of Budgets

•Need for more than one type of budget

•Various ways of classifying expenditures

•Benefits of performance budgets

•Key Phases of the Budget cycle

•Limitations of budget-to-actual comparisons

•How an encumbrance system prevents overspending



Key Purposes of BudgetingPlanning

Controlling and Administering

Reporting and evaluating


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Importance of government budgetsThe General Fund and special revenue funds usually require a legally adopted budget before the government can collect revenues from taxes and other sources and incur expenditures.

Severe penalties may exist for failure to comply with the budget, so it is imperative that the accounting system facilitate accounting for the budget as well as all other operating transactions.


Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. All rights reserved. 6

CITY OF HOUSTON

GENERAL FUND BUDGET FOR FISCAL YEAR 2015

(unaudited)

(amounts expressed in thousands)

Total Budgeted Resources $2,411,126,650

Total Budgeted Expenditures 2,256,343,561

(this is $171 million, 8.2% above the FY 2014 budget)

Budgeted Ending Fund Balance Unassigned

as of June 30, 2015 154,783,089

Total Budgeted Expenditures and FB $ 2,411,126,650

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Major types of BudgetsAppropriation BudgetMaster budget

Monitors current or operating fund (i.e. general fund)

Typically covers one operating cycle

Revenue and Other Support

Revenues are earned from the sale of goods and services and the receipt of contributions and grants.

Support refers to just contributions and grants.

Expenses represent the resources that an organization uses up in carrying on its activities.

A surplus or profit is the excess of revenues and support over expenses

A deficit or loss is an excess of expenses over revenues and support.



BudgetsCapital BudgetMonitors construction and acquisition of long-lived assets

Typically covers multiple years

Special types of Budgets

Special Purpose Budgets

Performance Budgets

Flexible and Zero-based Budgets

Contains alternative budget estimates based on varying levels of output

Helps distinguish fixed and variable costs

Most useful to business-type activities where level of activity depends on customer demand


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Expenditure and Revenue Classifications

Expenditure

• Fund

• Organizational unit

• Function or program

• Activity

• Character

• Object Classification

Revenues

(classified by fund then source)

• Taxes

• Licenses and Permits

• Intergovernmental revenues

• Charges for services

• Fines and Forfeits



Classification of Expenditures•Fund

• Ex. general fund, special revenue fund,

etc.

•Function or Program

• Def. Group of activities carried out with

the same objective

• Ex. general government, public safety,

sanitation, etc.

•Organization Unit

• Ex. police department, fire department,

etc.


•Activity

• Def. Line of work contributing to a function

or program

• Ex. highway patrol, burglary

investigations, etc.

•Character

• Def. The fiscal period presumed to benefit

• Ex. Current, Capital, Debt Service

•Object

• Def. The types of items purchased or

services obtained

• Ex. Salaries, fringe benefits, travel, etc.

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Classification of Revenues and Estimated Revenues


GASB Suggestion:◦ 1st classify by fund

◦ 2nd classify by sourceFUND

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Sources include:

• Taxes (Ad-valorem and self-assessing)

• Special Assessments

• Licenses and Permits

• Intergovernmental Revenues

• Charges for Services

• Fines and Forfeits

• Miscellaneous Revenues


Object Classification BudgetTraditional and most common

Characterized by expenditure classification that categorizes objects

Facilitates control

Drawbacks:• Discourages planning

• Promotes bottom-up rather than top-down budgeting

• Overwhelms top-level decision-makers with details

• Limits post-budget evaluation


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Performance Budgets•Supplement to object classification budgets

•Focus on measurable units of efforts, services, and accomplishments

•Institutionalize effective decision process

•The most common type of performance budget is program budget.



Key Phases of Budget Cycle


Preparation

Legislative adoption and

executive approval

Execution

Reporting and Auditing

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Budgeting: Planning for successFour Components:

Plan Establish mission

Develop Strategic Plan

Set Long-Range Plans

Prepare Budgets

Implement

Control

Measure Results and Report



Budgeting: A Part of PlanningThe Budget Cycle:

Preparation based on guidelines

normally done by responsibility center managers

Review and Adoption

Implementation and Control

Evaluation of Results and Feedback


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Budgetary Accounts Purpose: Used to record the budgetary inflows and outflows estimated or authorized in the annual budget

Accounts: Estimated Revenues, Estimated Other Financing Sources

Appropriations, Estimated Other Financing Uses

Encumbrances



Budgetary and Operating Statement AccountsRevenues and Other Financing Sources increase fund balance when closed. Both are

recognized on the Modified Accrual basis--when measurable and available to pay current

period obligations.

Expenditures and Other Financing Uses decrease fund balance when closed. Both are

recognized on the Modified Accrual basis--when incurred, if expected to be repaid from

currently available resources of the fund.

•An appropriation is a legal authorization granted by the legislative body to incur liabilities for

purposes specified in the appropriation act or ordinance.

•An encumbrance is an estimated amount recorded for purchase orders, contracts, or other

expected expenditures chargeable to an appropriation.


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Basis of AccountingNeither GASB nor FASB have control over budgeting principles Budgeting principles are directly set by either the government/organization or the

government/organization that supervises them

GASB recommends using modified accrual basis of accounting.

However, most governments use the cash basis for their budgets.



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The Monthly Treasury Statement is a monthly report of the government's receipts and outlays

The information is presented on a modified cash basis

Presented on next slide.


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Cash Basis Budgeting Governments using cash basis: Assign revenues and expenditures to the period during which the cash is expected to

be received or disbursed.

Treat encumbrances equivalent to actual purchases.

Recognize taxes and other revenues in the year in which they are due and not in the year in which they are expected to be collected.



Cash BasisDisadvantages: May distort the economic impact of planned fiscal activities.

May be unbalanced as to economic costs and revenues.

It may give an appearance of a budget that has achieved inter-period equity when it really has not.

Makes it easier to transfer resources from a fund that has a budget surplus to one that needs extra resources.

Complicates financial accounting and reporting.


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Current GASB Model (#34)Vs. Old Model

Old model: governments reported only their amended budget.

Current model: requires the actual results and both the original and final appropriated budgets.

Budgetary compliance can be assured by building safeguards in the accounting systems.



Legally adopted budgets vs. GAAP-based Financial StatementsDifferences arise between the legally adopted budgets and GAAP-based financial statements.

They are caused by: Basis of accounting

Timing

Perspective

Reporting entity


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Recording Budgets•Estimated revenues (DR) – Actual Revenues (CR) = Revenues still to be recognized

•Appropriations (CR) - Actual expenditures (DR) = Balance available for expenditure

•Refer to pgs. 117-118 for budgeting entries.



Example AA city government incorporates its budget in its accounting system and encumbers all commitments. Prior to the start of the year, the city council adopted a budget in which city revenues were estimated at $500,000 and expenditures of $450,000 were appropriated. Record the budget using only the control accounts.

Estimated revenues $500,000

Appropriations $450,000

Fund balance 50,000

Next slide shows what the detail might look like


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Example A - Detail


Budget Approved on 1-1-2015: Dr. Cr.Estimated Revenues 500,000

Appropriations 450,000Fund Balance 50,000

Revenues Ledger (detail):Taxes 300,000Licenses and Permits 50,000Intergovernmental Revenues 50,000Charges for Services 50,000Fines and Forfeits 25,000Miscellaneous Revenues 25,000Appropriations Ledger (detail):

General Government 120,000Public Safety 150,000Public Works 100,000Culture and Recreations 80,000

$500,000

$450,000


Encumbrance•Prevents overspending the budget (it’s a control mechanism)

•Entry to record encumbrance is made when purchase order is issued, a contract is signed, or a commitment is made.

•Entry that records encumbrance reduces the budget available for expenditure.

•Outstanding encumbrances are reported in the notes to the entity’s financial statements


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Impact of GASB 54Significant encumbrances must be reported in the notes to the financial statements • A separate display of encumbrances within fund balance categories is not permitted

• In the general fund - add encumbrances not related to restricted, committed or assigned purposes to the unassigned fund balance

• In special purpose funds - add encumbrances for specific purposes to the appropriate committed or assigned fund balance

• This requirement is necessary because special purpose funds cannot report a positive unassigned fund balance



Under GASB 54, encumbrances have

to be reported only in the notes

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Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. All rights reserved. Chapter 3 | 33

Under GASB 54, encumbrances have

to be reported only in the notes


Budgetary Control — ExpendituresBudgetary control of expenditures is achieved by:

ensuring that a valid appropriation exists prior to recording an encumbrance or expenditure

periodically comparing encumbrances and expenditures to appropriations.

Comparison is enhanced by using a common classification scheme for appropriations, encumbrances, and expenditures


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Example B - Budgetary ControlCity Clerk's office orders a new multi-purpose machine on January 2, 2015 which had a list price in the vendor's catalog of $1,750.

General Fund General Journal:

Dr. Cr.

Encumbrances--2015 $1,750

Reserve for Encumb.--2015 $1,750



Accounting Control over ExpendituresAppropriations (expenditure budget)

Estimated revenues & other sources of financing (revenue budget)

Encumbrances (unfilled orders)

• The sum of the detailed Appropriations, Encumbrances, and Expenditure account balances of the subsidiary ledger must equal the general ledger control account balances


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Budgeting Formats•Line item or object of expense

• Ex. - salaries, benefits, supplies, rent, etc.

•Responsibility Center - units for which individual managers are held accountable

• Ex. - custodial services, maintenance, public relations, development, ticket sales, etc.

•Program Budgets include both revenues and expenses

• Ex. - ballet, opera, philharmonic, etc.

Generally, both Responsibility Center and Program budgets are supported by line item detail.



**Various expenditures by function breakdowns shown on next 3 slides

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Granof, et al. – 7th edition


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Example CA government health care district incorporates its budget in its accounting system and encumbers all purchase orders and contracts. Prior to the start of the year, the governing board adopted a budget in which agency revenues were estimated at $5,600 and expenditures of $5,550 were appropriated. Record the budget using only the control accounts.

JE 1: Estimated revenues $5,600


Fund balance 50


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Example - C (cont’d)JE 2: During the year, the government health care district collected $5,800 in fees, grants, taxes, and other revenues. Prepare journal entries.

Cash $5,800

Revenues 5,800

JE 3: It ordered goods and services for $3,000.

Encumbrances $3,000

Reserve for encumbrances 3,000



Example – C (cont’d)JE 4: During the year it received and paid for $2,800 of goods and services that had been previously

encumbered. It expects to receive the remaining $200 in the following year.

a: Expenditures $2,800

Cash 2,800

b: Reserve for encumbrances $2,800

Encumbrances 2,800

JE 5: It incurred $2500 in other expenditures for goods and services that had not been encumbered.

Expenditures $2,500

Cash 2,500


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Example –C (cont’d)Prepare end of year closing entries.

JE 6: Revenues $5,800

Estimated revenues 5,600

Fund balance 200

JE 7: Appropriations $5,550

Expenditures 5,300

Encumbrances 200

Fund balance 50



Supporting Computations – original styleReserve for

Encumbrances

dr cr balance

bal fwd $0

3 3,000 (3,000)

4b 2,800 (200)

(200)

Encumbrances

(temporary acct)

dr cr balance

bal fwd 0

3 3,000 3,000

4b 2,800 200

7 200 0

Fund balance

(unassigned)

dr cr balance

bal

fwd 0

1 50 (50)

6 200 (250)

7 50 (300)

Total fund balance at year end:

Fund balance –committed

(Reserved for encumbrances ) 200

Fund Balance Unassigned 300

Total 500

This should equal revenues – expenditures

(since bal fwd in FB was 0)

Revenue – Expenditures = 5,800 – 5,300 = $500

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Example C (alternate style closing)

Fund= General Fund Debit Credit

JE 6 Reverse original budgetary entry:


Fund balance (unassigned) 50

Estimated revenues 5,600

JE 7 Close revenue, expenditure & encumbrance accounts

Revenues $5,800

Expenditures 5,300

Encumbrances 200

Fund balance (unassigned) 300


Supporting Computations – alternate styleReserve for Encumbrances

dr cr balance

bal fwd $0

3 3,000 (3,000)

4b 2,800 (200)

(200)

Encumbrances

(temporary acct)

dr cr balance

bal fwd 0

3 3,000 3,000

4b 2,800 200

7 200 0

Fund balance

(unassigned)

dr cr balance

bal fwd 0

1 50 (50)

6 50 -

7 300 (300)

Total fund balance at year end:

Fund Balance –committed

(Reserved for

encumbrances) 200

Fund Balance -Unassigned 300

Total 500

This should equal revenues -

expenditures 5,800

since balance fwd was zero 5,300

TRUE 500

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City of Houston - FactsDid you know?

• The final sales tax revenue for FY 2014 was $620 million, an increase of 20 million from $600 million, FY 2013 amount.

• Sales taxes comprise 28% of the city’s revenue source for governmental activities in FY 2014.

• Total unassigned fund balance of the General Fund for FY 2014 was $136 million.



Summary •The General Fund and special revenue funds usually require a legally adopted budget before the government can collect revenues from taxes and other sources and incur expenditures.

•Severe penalties may exist for failure to comply with the budget, so it is imperative that the accounting system facilitate accounting for the budget as well as all other operating transactions.


Documents

Chapter 3Basis of Accounting Neither GASB nor FASB have control over budgeting principles Budgeting principles are directly set by either the government/organization or the government/organization