GOVERNMENTALAND NONPROFITACCOUNTINGTheory and Practice

TENTH EDITION

Robert J. FreemanTexas Tech University

Craig D. ShouldersWestern Carolina University

Gregory S. AllisonUniversity of North CarolinaChapel Hill

G. Robert Smith, Jr.Middle Tennessee State University

PEARSONBoston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam

Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto DelhiMexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

Contents

Preface xxi

CHAPTER 1Governmental and Nonprofit Accounting: Environment and Characteristics 1

Characteristics and Types of G&NP Organizations 2G&NP Sector Significance 2The G&NP Environment 3

Objectives of G&NP Accounting and Financial Reporting 6

Authoritative Sources of G&NP Accounting Principles and Reporting Standards 6TheFAF 7TheFASB 7FASB-GASB Jurisdictions 7"Government" Defined 7TheGASB 9GAAP Hierarchies 11

Concepts and Objectives of SLG Accounting and Financial Reporting 12Governmental-Type Activities 13Financial Report Users 17Financial Report Uses 18Business-Type Activities 18Users and Uses of Financial Reports 19Financial Reporting Objectives 20

Characteristics of SLG Accounting and Financial Reporting 21Fund Accounting 21Budgets and Appropriations 22Other Distinguishing Characteristics 23Commercial Accounting Comparison 24

Concluding Comments 24

APPENDIX 1-1 Evolution of Accounting Principles and Standards—Prior to the GASB 25

Questions 28

Exercises 28

Problems 30 . ]

CHAPTER 2State and Local Government Accounting and FinancialReporting Model: The Foundation 31

Overview of the GASB Financial Reporting Model 32

The Fundamental Features of the SLG Accounting and Financial Reporting Model 33GAAP and Legal Compliance 35Fund Accounting 36Fund Categories 37Transaction Analysis 42Types of Funds 45Comparative Financial Statement Formats 50Annual Financial Reporting 55

IX

X Contents

Concluding Comments 58Questions 59Exercises 60 \Problems 64Cases 67

CHAPTER 3The General Fund and Special Revenue Funds 69

Measurement Focus 70Purposes and Assumptions of This Chapter 71 r

General Fund Accounting—Illustrative Example 71Entries During 20X1 71Year-End Adjustments 83Preclosing Trial Balances 84Illustrative Example Worksheets 8420X1 Closing Entries 84Postclosing Trial Balance 86

Balance Sheets 87Interim Balance Sheet 87Year-End Balance Sheet 87Fund Balance 88Fund Balance Reporting Classifications 89Interfund Receivables and Payables 92Capital Assets and Long-Term Liabilities 92

Statement of Revenues, Expenditures, and Changes in Fund Balances 93Restatements 94Extraordinary Items and Special Items 95

Classification of Expenditures 95Combining Special Revenue. Fund Statements 98Concluding Comments 100APPENDIX 3-1 General Ledger Worksheet and Subsidiary Ledgers 100APPENDIX 3 -2 Classification of Expenditures 100APPENDIX 3 -3 Alternative Account Structure and Entries 109Questions 110Exercises 110Problems 115Cases 119

CHAPTER 4Budgeting, Budgetary Accounting, and Budgetary Reporting 121The Government Budgetary Perspective 122Budgetary Accounting and Reporting 123

Budgetary Accounting and Control 123Recording the Budget—General Ledger and Subsidiary Ledger 127Budget Revisions 127Revenues and Expenditures Ledgers Incorporating

Budgetary Accounts 132Level of Detail in Subsidiary Ledgers' 137

Budgetary Reporting Overview 137The Budgetary Basis 138Interim Budgetary Statements 138

Contents XI

Budget Comparison Schedule or Statement of Revenues, Expenditures, and Changesin Fund Balance—Budget and Actual 140

Budgetary Comparison Statement Illustrated—Budgetary Basis'-.Same as GAAP 141Budgetary Comparison Statement Illustrated—Budgetary Basis Differsirom GAAP 143

Entries during 20X2 145

Budgetary Planning, Control, and Evaluation 146Planning 146Control 146Evaluation 147

Basic Budgetary Terminology 147 t

Capital vs. Current Budgets 147Tentative vs. Enacted Budgets 148General vs. Special Budgets 149Fixed vs. Flexible Budgets 150Executive vs. Legislative Budgets 150

Budgetary Approaches and Emphases 150

Budget Preparation 151Overview 151Preliminary Estimates 151Preparing the Budget 152Revenue Estimates and Requests 153Expenditure Estimates and Requests 153Expenditure Budgeting Approaches 153

Legislative Consideration and Action 155

Budget Execution 156

Concluding Comments 157

Questions 157

Exercises 158

Problems 162

Cases 166

Harvey City Comprehensive Case 169

CHAPTER 5

Revenue Accounting—Governmental Funds 174

Revenue Definition and Recognition 175

Nonexchange Transactions 177

Governmental Fund and Proprietary Fund Revenue Recognition Compared 179

Classification of Revenue Accounts 181General Fund Revenues 181Other Governmental Funds Revenues 181

Taxes 182Taxpayer-Assessed Taxes 182Property Taxes 183Property Tax Statements/Schedules 192

Licenses and Permits 192

Intergovernmental Revenues 193Intergovernmental Revenue Classifications 193 :

Intergovernmental Revenue Accounting 194

Charges for Services 197Interfund Services vs. Reimbursements 197Charges for Services 197

XII Contents

Fines and Forfeits 199

Investment Earnings 200

Miscellaneous Revenues 203Escheats 203Private Contributions 204

Selected Nonrevenue Fund Balance Increases 204Capital Asset Sales/Losses 204Internal PILOTs 204Collateralized Borrowings 205

Revenue Reporting: GAAP vs. Budgetary 205 '

Balance Sheet Reporting Related to Unrecognized Revenues 205

Changes in Accounting Principles 208

Error Corrections 209

Concluding Comments 209

Questions 210

Exercises 210

Problems 214

Cases 218Harvey City Comprehensive Case 220

CHAPTER 6Expenditure Accounting—Governmental Funds 222

Expenditure Definition and Recognition 223Capital Outlay Expenditures 224Debt Service Expenditures 225Intergovernmental Expenditures 2 2 5 /Current Operating Expenditures 225Inventories and Prepayments 225Expenditure Recognition Summary 226

Expenditure Accounting Controls 227

Expenditure Accounting Procedures 227• Personal Services 228

Materials and Supplies 230Other Services and Charges 232

Adjusting Entries 235Encumbrances 237Debt Service 238Claims and Judgments 238Compensated Absences 242Pension/OPEB Plan Contributions 243

Expenditure Reporting: GAAP vs. Budgetary 244

Changes in Accounting Principles 247Alternative Principles 247New GASB Standards 248

Error Correction 249

Concluding Comments 249

Questions 250

Exercises 250

Problems 252

Cases 258

Harvey City Comprehensive Case 260

Contents XIII

CHAPTER 7Capital Projects Funds 262Capital Projects Fund Operations and Accounting Standards 264

CPF Financial Resources 264Number of Funds 264CPF Life Cycle 265The Budget 266Interim Financing 267Project Costs 268Intergovernmental Revenues 269Recording Bond Issues 269

Capital Projects Fund—Case Illustration Begun, 20X1 269Budgetary Entry 270Transaction/Event Entries 271General Ledger Worksheet(s) 272Preclosing Trial Balance 274Closing Entries 274Financial Statements 275

Capital Projects Fund—Case Illustration Concluded, 20X2 27820X1 Accounts Closed 278Case Illustration Assumptions and Entries—20X2 278General Ledger Worksheet 28020X2 Financial Statements 281

Other Capital Projects Fund Operations, Accounting, and ReportingMatters 284

Bond Anticipation Notes (BANs) 284Investments and Arbitrage 285Remaining Fund Balance 285Reporting Multiple Projects 286 -Combining CPF Statements 286

Concluding Comments 287Questions 287Exercises 287Problems 291Cases 297Harvey City Comprehensive Case 299

CHAPTER 8Debt Service Funds 301Debt Service Fund Environment, Financing, and Expenditure

Recognition 302Long-Term Liabilities 302Fixed vs. Variable Rates 303Debt Service Payments 304Bonds and Fiscal Agents 304Required DSF Reserves 305Bond Ratings 305Bond Insurance 305Sources of Financing 306

, DSF Investments 306DSF Expenditure Recognition 306

Debt Service Fund for a Serial Bond Issue: Case Illustration 307Illustrative Entries 308Financial Statements 310

XIV Contents

Special Assessment Debt Service Funds 311Illustrative Entries 312Illustrative Financial Statements 314 '!

Other Conventional Debt Service Fund Considerations 315Nonaccrual of Interest 315Combining Balance Sheet 315Combining Operating Statement 316

Debt Service Fund for a Term Bond Issue 316

Sinking Fund Requirements 318

Debt Service Funds for Deep Discount Issues 319 '

Refundings 320Reasons for Refund ings 320Refundings Defined 320Defeasance of Debt 321

Debt Service Funds for Refundings 323Current Refunding 324Advance Refunding' 325Debt and Nondebt Financing 326Reporting Refundings 327 f

Advance Refunding Disclosures 327

Concluding Comments 330

Questions 331

Exercises 332

Problems 335

Cases 340

Harvey City Comprehensive Case 341

CHAPTER 9General Capital Assets; General Long-Term Liabilities; Permanent Funds:Introduction to Interfund-GCA-GLTL Accounting 343

Overview of General Capital Assets and General Long-TermLiabilities Accounting Procedures 344

General Capital Assets 345General Capital Assets Defined 345Initial Valuation 346Classification 347 • 'Capitalization Policy 347Property Records 349Capital Assets Inventory 350Additions, Betterments, and Renewals 350Depreciation/Accumulated Depreciation 351Updating GCA Accounts 352Recording Depreciation 356Sale, Replacement, or Retirement 356Intragovernmental Transactions 357Impairment 359Insurance Recoveries 361Damage or Destruction 362Reporting and Disclosures 363

General Long-Term Liabilities 363CPF-DSF-GLTL 366Serial Debt 366

Contents XV

Special Assessment Debt 367Other Government Liabilities 367Interest-Related Adjustments 368Defaulted Bonds 369In-Substance Defeasance 369GLTL Records 369GLTL Reporting and Disclosures 370

Permanent Funds 3 7 0Introduction to Interfund-GCA-GLTL Accounting 373Concluding Comments 3 7 8Questions 378Exercises 379Problems 383Cases 387Harvey City Comprehensive Case 3 8 9

CHAPTER 10Enterprise Funds 3 9 2 c

Common Characteristics and Principles ofProprietary Funds 392

Accounting Equation 392Accounting Principles 393Financial Statements 393

Enterprise Funds Defined 3 9 4

EF Accounting Illustrated 3 9 5

Budgeting and Appropriations 396Interfund Activity * 396 'Intergovernmental Grants 396Interest Capitalization 397Establishment of Fund and Acquisition of Plant 397Accounting for Routine Operating Transactions 398Preclosing Trial Balance and Financial Statements—Basic Example 401

EF Accounting—Extended Illustration 4 1 0

Enterprise Fund Reporting—Extended Example 4 2 0

Combining Enterprise Fund Financial Statements 4 2 5

Concluding Comments 4 2 9 •'

Questions 4 2 9

Exercises 4 3 0

Problems 4 3 3

Cases 4 3 8

Harvey City Comprehensive Case 4 4 1

CHAPTER 11Internal Service Funds 443Overview of Accounting Principles 4 4 4

Initial Establishment 444Pricing Policies 446Pricing Methods 447Relation to Budget 448Financial Statements 448

XVI Contents

Internal Service Fund Accounting Illustrated 448Automotive Equipment Unit 448Central Stores Fund 452 \

Self-Insurance Fund 456

Disposition of Increase or Decrease in Net Position 461

Dissolution of an Internal Service Fund 461

Combining Internal Service Fund Financial Statements 462

Concluding Comments 465

Questions 465

Exercises 466

Problems 468

Cases 471

Harvey City Comprehensive Case 472

CHAPTER 12

Trust and Agency (Fiduciary) Funds: Summary of Interfund-GCA-GLTL Accounting 474

The Accountability Focus 475

Agency Funds 476Simpler Agency Funds 477Tax Agency Funds 477Special Assessment Agency Funds 482

Trust Funds 483Private-Purpose Trusts 483Investment Trusts 485Pension Trusts 486

Combining Trust and Agency Fund Financial Statements 494

Additional Interfund-General Capital Asset-General Long-Term Liability Accounting Illustrations 495

Concluding Comments 500

Questions 501

Exercises 501

Problems 504

Cases 507

Harvey City Comprehensive Case 509

CHAPTER 13Financial Reporting: The Basic Financial Statements and RequiredSupplementary Information 510

Basic Financial Statements Overview 512

Fund Financial Statements 513Major Fund Reporting 513Fund-Based Financial Statements 523

Government-Wide Financial Statements 526Statement of Net Position 528Statement of Activities 529Measurement Focus 532Reporting Expenses 533Program vs. General Revenues 533Internal Service Funds 536Infrastructure Capital Assets 537

Note Disclosures 537

Contents XVII

Required Supplementary Information 539Management's Discussion and Analysis 539Other RSI 539Special Purpose Governments 539

Concluding Comments 541

Questions 541

Exercises 541

Problems 544

Cases 547

Harvey City Comprehensive Case 550

CHAPTER 14

Financial Reporting: Deriving Government-Wide Financial Statements and Required Reconciliations 551

Deriving Governmental Activities Data 553

Deriving Government-Wide Financial Statement Data for Governmental Activities—A Worksheet-Based Approach 554The Conversion Worksheets 554Balance Sheet Conversion Worksheet Adjustments 559Farley County Balance Sheet Conversion 562Operating Statement Conversion Worksheet Adjustments 564Farley County Operating Statement Conversion 567

Deriving Business-Type Activities Data 570Statement of Net Position 572Statement of Activities 572Reconciliations 575

Concluding Comments 577

APPENDIX 14-1 A One-Worksheet Approach to Deriving Governmental Activities Data 577Questions 587

Exercises 588

Problems 591

Cases 598

Harvey City Comprehensive Case 602

CHAPTER 15Financial Reporting: The Comprehensive Annual Financial Reportyand the Financial Reporting Entity 603

The Comprehensive Annual Financial Report 604The Introductory Section 604The Financial Section 606The Statistical Section 610

Supplemental and Special Purpose Reporting 614

Financial Reporting—Complex Entity Structure 614Reporting Entity Definition 614Reporting Entity Disclosures 617

Integrating Component Units into the Reporting Entity 617Blending 621Discrete Presentation 621Dual Reporting Entity Model 623

Other Issues 623

Separate Issuance of Primary Government Financial Statements 624

Related Organizations, Joint Ventures, and Jointly Governed Organizations 624

Concluding Comments 625

XVIII Contents

Questions 627

Exercises 628

Problems 631 \

Cases 634

Harvey City Comprehensive Case 636

CHAPTER 16Non-SLG Not-for-Profit Organizations 637

Classification of Organizations 639Voluntary Health and Welfare Organizations 639Other Not-for-Profit Organizations 639

Classes of Net Assets 640

Non-GAAP Accounting and Reporting Requirements 641

Basis of Accounting 641

Financial Statements 641Balance Sheet 64.1Statement of Activities 643Statement of Cash Flows 650Statement of Functional Expenses 650

Nongovernment VHWO and ONPO Accounting and Reporting Illustration 650Transactions and Entries 650Illustrative Financial Statements 658

Concluding Comments 664

Questions 665

Exercises 665

Problems 669 /

CHAPTER 17Accounting for Colleges and Universities 675

Classification as "Engaged Only in Business-Type Activities" 676

GAAP Reporting Requirements 677Statement of Net Position 677Operating Statement 679Statement of Cash Flows 685

Case Illustration—A Government University 685 iOther Resources 689

Annuity and Life Income Gifts 695Annuity Gifts 695Life Income Gifts 699

Colleges and Universities Engaged in Both Governmental and Business-Type Activities 700

Nongovernment Not-for-Profit University Reporting 700

Concluding Comments 704

Questions 704

Exercises 704

Problems 706

CHAPTER 18Accounting for Health Care Organizations 713

Funds—Government Hospitals 714Basic Principles 715

Contents XIX

Unique Measurement and Display Features 715Distinguishing Primary Activities 715Classes of Revenues 715Gains 718Donations 718Expense Classification 718Restricted Assets 719Property, Plant, and Equipment 720

Illustrative Case 720Summary of Transactions and Events 720

Financial Statements 729Statement of Net Position 729Operating Statement 729

Statement of Cash Flows 729

Nongovernment Not-for-Profit Hospital Reporting 729

Concluding Comments 736

Questions 736

Exercises 737

Problems 740

CHAPTER 19Federal Government Accounting 743

The Federal Financial Management Environment 744Financial Accounting Responsibilities 744Overview 746

The Budgetary Process 747The Budget Cycle 747Exceeding Budget Authority 750 '

Accounting Principles and Standards for Federal Agencies 750The Federal Model 750Standard General Ledger 754Federal Fund Structure 755Financial Reporting 755

Federal Agency Accounting and Reporting Illustrated 759A Case Illustration 759Maintaining Budgetary Control 759Maintaining Proprietary Accounts 764Other Transactions and Entries 764Closing Entries 768Reporting 770

Concluding Comments 775

Questions 775

Exercises 775

Problems 777

CHAPTER 20Auditing Governments and Not-for-Profit Organizations 780

Overview 781

What Is an Audit? 781Classifications of Audits 781Management's Representations 783External Auditor Classifications 783Engagement Letter 784

XX Contents

Auditing Standards 784AICPA Auditing Standards 784GAO Auditing Standards 786 "\GAGAS 2011 Summary 787

The Financial Audit 7891 Auditing Standards 789

Audit Procedures 789The Audit Report 790

The Single Audit 792Purposes 793Applicability 793Definitions 794Objectives 794Overview 794Auditee Responsibilities 795Auditor Responsibilities 795Auditing Guidance 799Major FFA Programs' 800Findings & Questioned Costs 803Illegal Acts 804Subrecipients 805Auditor Reports—Single Audit 805 n

Auditee Reporting Responsibilities 808Other Matters 809

Concluding Comments 809

APPENDIX 20-1 Glossary 8 0 9APPENDIX 20 -2 Data Collection Form for Reporting on Audits of States, Local

Governments, and Nonprofit Organizations 8 1 1Questions 815

Exercises 815

Problems 819

Cases 820

Index 823