Chapter 5 1

Chapter 5

Recognizing Expenditures in Governmental Funds

Chapter 5 2

Learning Objectives

Modified accrual basis

Full accrual basis

Accounting for different expenditures

Types of interfund activities and how they are reported

Other Financing Sources and Uses

Chapter 5 3

Modified Accrual Accounting

Criteria : Measurable and Available Measurable : Government is able to

determine or reasonably estimate the amount.

Available : Collectible within the current period or soon enough thereafter to be used to pay liabilities of the current period.

Chapter 5 4

Expenditures & Expenses

Expenditures (measure of fund liabilities liquidated with current resources)

-Modified accrual basis--Governmental funds

-Are decreases in net current financial resources

Expenses (measure of costs expired or consumed during a period)

-Full accrual basis--Government-wide Statements

-Reduction in net economic resources

Chapter 5 5

Expenditures

Expenditures are closely tied tocash flows and near-cash flows

Governmental funds report only current liabilities and not long-term liabilities.

A government recognizes expenditures when it pays cash for goods and services received or accrues a liability.

Chapter 5 6

Expenditure Definition and Recognition

Definition - Decreases in Fund Net Assets NOT resulting from Transfers (and refunding transactions)

NORM – Recognize when FUND Liability is incurred Exceptions:

--Debt Service Expenditures on GLTD – When Legally Due

--Either Purchases or Consumption Basis for Materials, Supplies, and Prepaid Items

--Pensions, Claims and Judgments, Compensated Absences – When Payable from Available Expendable Financial Resources

--Capital Leases – on Substance vs. Form Basis

Chapter 5 7

GAAP

GASB Codification, paragraphs 1600.102 through 1600.105.

The Codification asserts that the “accrual basis is the superior method of accounting for the economic resources of any organization,” and states that the “use of the accrual basis to the fullest extent practicable is recommended.”

Chapter 5 8

Salaries and Wages

May be earned in one fiscal year but paid in the next.

Should be recognized in the period in which it is earned provided the government’s obligation will be liquidated with expendable available financial resources.

Chapter 5 9

Payroll accounting is similar for a governmental fund and a for-profit entity, except Expenditures rather than Expenses are recorded.

Example: Wages and related benefits of employees for the last pay period in December 2006 were $40 million. Employees are to be paid on January 6, 2007. The fiscal year ends December 31.

General Fund DR CR

Wages and benefits expenditures $40

Accrued wages payable 40

Government-wide: same.

Salaries and Wages (Payroll)

Chapter 5 10

Debit Expenditures for the full amount of payroll and credit liabilities for withholdings from employees pay; credit Cash for the amount paid to employees.

Example: Timbaktu City recognized its payroll for the most recent two week pay period for employees paid from the General Fund.

GF General Journal Dr. Cr.

Expenditures--2007 948,000

Due to Federal Gov’t 86,000

Due to State Gov’t 49,000

Cash 713,000

The Subsidiary Ledger provides the details of the total expenditure as follows:

General Government 178,000

Public Safety 480,000

Public Works 290,000

Payroll (cont’d)

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Record Expenditures for the employer’s payroll costs, including employer’s share of FICA and credit a liability to federal government.

Encumbrances usually are not recorded for recurring expenditures such as payroll.

The employer’s share of FICA is recorded.

GF General Journal Dr. Cr.Expenditures--2007 $188,000

Due to Federal Gov’t 188,000

Expenditures Subsidiary Ledger: Contributions for Retirement 188,000

Payroll (cont’d)

Chapter 5 12

Governments Vs. Business 7 Major differences between the application of

accrual method in governmental funds and business:

Compensated absences Pension accounting Claims and Judgments Inventory accounting Prepayments Accounting for capital assets Accounting for interest and principal

Chapter 5 13

Compensated Absences (CA)

They are earned in one period but often not paid until several periods later. Therefore, its not current.

Amount of compensation to be paid is not always certain. It is based on the salary/wage rate in effect when the time off is taken.

GASB states that vacation leave and compensated absences should be accrued as a liability as the benefits are earned if BOTH the following conditions are met:

-Attributable to services already rendered and -Probable that compensation will occur (paid

time off or other means)

Chapter 5 14

Compensated Absences: (Cont’d) Vacation pay expenditures and related fund liabilities

should be recognized in the periods in which they are due. Until those periods, those liabilities are reported ONLY in

the schedule of long-term obligations. Example: City employees earned $300,000 in vacation

leave they did not take in 2007. The leave vests and can be taken at any time up to retirement.

Government-wide: DR CR

Vacation pay expenditure $300,000 Accrued vacation payable 300,000

Chapter 5 15

Vacation Leave Example: City employees earn $8 million in vacation

leave. Of this amount, they are paid $6 million in 2007 and defer the balance until future years.

Governmental fund DR CRVacation pay expenditure $6

Cash (or Wages Payable) $6

The $2 million deferred until future periods should be reported in a schedule of long-term obligations.

Government-wide statements DR CRVacation Pay expense $8

Cash (or Wages Payable) $6Accrued Vacation Pay $2

Chapter 5 16

Sick Leave

Beyond the control of both the employee and the employer.

GASB states that sick leave is recognized as a liability only if it is probable that the employer will compensate the employees for the benefits through cash payments conditioned on the employees’ termination or retirement.

It should be recorded ONLY when expected to be paid to employees upon their resignation or retirement.

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Example-Sick Leave

Example: City employees earned $170,000 in sick leave but were only paid for $140,000. The leave accumulates but does not vest.

Governmental fund DR CRSick leave expenditure $140,000

Cash $140,000

The city will not have to compensate employees for leave not taken as a termination benefit. It should charge as an expenditure only the amount that was liquidated with expendable financial resources. It need not report a liability even in the schedule of long-term obligations.

Government-wide: Same rules apply. But only the $140,000 paid needs to be charged as an expense.

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Sick Leave (cont’d)• Example: A city pays for its employees’ unused sick leave up to

thirty days only if they terminate at least after 10 years of service. In 2007, the city had the following estimates: -Sick leave earned = $12 mil; Payments to future employees = $8mil-Payments to 10-year employees upon termination = $1mil-Amount that will not be paid = $3mil

Governmental fund:No entry is required. The city recognizes a liability only for the $1 million to be paid in termination benefits. Assuming that those termination benefits are not paid in the current year, it is recognized in the schedule of long-term obligations

Government-wide: DR CRSick leave termination benefit expense $1

Accrued Sick Leave $1

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Sabbatical Leave After a specified term of service, employees may be

granted a paid leave. They are offered to benefit both the employee and the

employer in the future, not the past. The employees are required to perform other activities that

will enhance their job-related abilities during their time off.

GASB states that the accounting for sabbatical leave depends on the purpose of the leave.

During the leave, if the employees are required to engage in activities to enhance their job-related skills, then it should be accounted for in the period the leave is taken.

Instead, if the leave is for “compensated unrestricted time off,” then the liability is accrued during the period the leave is earned.

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Sabbatical Leave- Example

City teachers are entitled to sabbatical leaves of six months every 7 years for research and renewal. The 2007 share of leave costs to be taken in the future was $300,000.

Sabbatical leaves need not be recognized as a liability unless the leave is a reward for past service (i.e. it is for unrestricted time off). It need not be accrued if it constitutes merely a change in assigned duties (e.g.) research instead of teaching).

Government-wide: same.

Chapter 5 21

Pensions Definition: Amount of money paid to

retired or disabled employees. If the Government makes the required

contribution to the pensions in full, then the amount to be recorded would be the amount of contribution.

According to GASB, the expenditure should be the amount that will be liquidated with expendable available financial resources.

Chapter 5 22

Pensions - Example

According to city actuaries, employees earned $370,000 inpensions. However, the city had budgeted only $300,000.During the year it contributed to its pension fund $250,000 and plans to contribute an additional $50,000 in early Jan.2007.

General Fund DR CRPension expenditure $300,000

Cash $250,000 Current obligation to

Pension fund $50,000Government-wide: The entire $370,000 earned by employees

would be charged as an expense.

Chapter 5 23

Pensions - Example• A city is estimated to contribute $55 million to its pension

fund. However, it elects to contribute only $45 million.

Governmental fund: DR CRPension expenditure $45

Cash (or current pension liability) $45

Government-wide: DR CRPension expense $55

Cash/Current pension liability $45Pension liability $10

Chapter 5 24

Claims and Judgments (CJ)

Common examples: Injuries to employees

Negligence of government employees

Contractual disputes with suppliers

Employment practices

Chapter 5 25

Claims and Judgments (CJ) GASB Std. #10, Claims and Judgements, para. 53. (also FASB

Std. # 5) Liability accrued if:

-Probable that Asset Impaired/Liability Incurred by Balance Sheet date

-Loss can be reasonably estimated Expenditure recognized in the governmental fund only for the

portion of liability that is:-Normally to be Liquidated with Available Expendable Financial

Resources-Liability recorded at “face value.”

Balance of liability is in GLTDAG – -No expenditure recognized-Expense is recognized in the government-wide statements at the

time the loss liability first satisfies the FASB No. 5 criteria.

Chapter 5 26

Claims and Judgments -Example

The city settled a judgment brought against it by an injured employee. The city agreed to pay $6 million in 2005 and $4 million in each of the next five years.

General Fund: DR CR Expenditures $6

Claims payable $6Government-wide: Assuming discount rate of 6% and 5

payments at the end of the following five years. DR CR

Expenses $22.8Claims payable (current) $ 6.0Claims payable (long-term) 16.8

Chapter 5 27

Are not expendable available financial resources Unlike businesses, governments do not acquire inventories

with the intention to resell them. Instead, they use it to carry out day-to-day operations. Two Primary issues pertaining to governmental fund are:

-Timing of the expenditure-Reporting of the asset

Two methods of accounting-Consumption Method-Purchases Method

Under each method we assume that periodic rather than perpetual inventory accounts are maintained;

All purchases are debited to Expenditures and that the Inventory of Supplies account is updated at year-end as an adjusting entry.

Materials and Supplies

Chapter 5 28

Consumption Method. Assume the following data:Beginning inventory $ 20,000

Purchases during year 150,000

Available for use 170,000

Ending inventory (15,000)

Amount consumed $155,000

Adjusting Journal Entries: Dr. Cr.Expenditures--2007 $5,000

Inventory of Supplies 5,000

Reserve for Inventory of Supplies 5,000

Fund Balance 5,000

Materials and Supplies (cont’d)

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Purchases Method. Assuming the same data:Beginning inventory $ 20,000Purchases during year 150,000Available for use 170,000Ending inventory (15,000)Amount consumed $155,000

Adjusting Journal Entries: Dr. Cr.Reserve for Inventory of Supplies $5,000

Inventory of Supplies 5,000(Note that the Expenditures account is not affected by the adjusting entry)

Materials and Supplies (cont’d)

Chapter 5 30

Materials and Supplies (cont’d)

Government-wide statements: Should be reported on a consumption basis.

Supplies expense rather than supplies expenditure would be debited.

No need for inventory reserve.

Chapter 5 31

Materials and Supplies – Add. Examples

In 2007 the City ordered supplies that cost $4 million, received supplies that cost $3.5 million, paid for supplies that cost $3 million and used supplies that cost $3.3 million.

Common Entries: Dr. Cr.

Encumbrances $4

Reserve for encumbrances $4

Reserve for encumbrances $3.5

Encumbrances $3.5

Accounts Payable $3

Cash $3

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Example (cont’d)Purchases method: DR CR Supplies expenditure $3.5

Accounts Payable $3.5Supplies inventory $0.2

Fund balance $0.2Consumption method:

Inventory $3.5Accounts payable $3.5

Supplies expenditures $3.3Inventory $3.3

Fund balance (unrestricted) $0.2Fund balance (reserved) $0.2

Government-wide: Must use consumption method.

Chapter 5 33

Prepayments

GASB standards: Either purchases or consumption method can be

used. But in the government-wide statements, only consumption method may be used.

Expenditures for insurance and similar services extending over more than one accounting period need not be allocated between or among accounting periods.

GASB does not distinguish between current and long-term prepayments.

Chapter 5 34

Prepayments -ExampleOn June 15, 2007 the city acquired and paid for an insurancepolicy that cost $300,000. The policy covers the one-year

period beginning July 1.

Purchases method: DR CRInsurance expenditure $300

Cash $300Consumption method:Prepaid insurance $150Insurance expenditure 150

Cash $300

Government-wide: Must use consumption method.

Chapter 5 35

Capital Assets Provide services in periods beyond those in which they are

acquired. Government funds account for capital assets in the same

way as businesses. GASB standards:

-General capital assets – are not specifically related to activities that are reported in proprietary or fiduciary funds.

-General capital assets are neither reported on governmental fund balance sheets nor depreciated on governmental fund statements of revenues, expenditures, and changes in fund balance.

-Governments reports general capital assets in the period requiring the outflow of expendable available financial resources.

Chapter 5 36

Capital Assets - Example

The city acquired a computer at a cost of $3 million, and paidin cash. It has a useful life of three years.

General Fund: DR CR

Expenditure-acquisition of capital assets $3

Cash $3

Government-wide: Would capitalize and depreciate

Chapter 5 37

Capital Assets - ExampleIt acquired the same computer, issuing a 3 year, 6%, installment

note for the purchase price. During the year it paid the first installment of $1,122,330 (interest=$180,000, principal=$942,330).

General Fund: Expenditures- -acquisition of capital assets $3 mil

Other financing sources $3 milExpenditures-debt service $180k

Cash $180kExpenditures-debt service

(principal) $942,330Cash $942,330

Government-wide: would capitalize and depreciate

Chapter 5 38

General Government Leases Capital Lease Vs. Operating Lease

Classify leases per FASB 13 Operating leases

-Lessor remains the owner of the property.-Typically Recorded as Expenditures in Period Paid or Accrued

Capital leases-Equivalent of a purchase-borrow transaction.-Lessee (the party that will use the property) becomes the owner.-Lessee treats the lease as a purchase. -Periodic payments are made plus interest.

Capital leases -- at inception:-Expenditures = Capitalizable Cost of Leased Asset-Other Financing Source = Capitalizable Cost Less Initial Down

Payment-Also – Capital Lease Liability in GLTDAG Leased Asset in CFAAG

Capital leases – subsequent payments:-In Substance – Are Debt Service Expenditures on GLTD-Also – Reduce Lease Liability by Principal Reduction

Chapter 5 39

Leases - ExampleThe City leased a computer, which has a fair market value of

$3 million and an estimated useful life of three years. The lease cannot be canceled. The lease payment for 2005 was $1,122,330 (interest of $180,000 and principal of $942,330).

General Fund:Expenditures – acquisition of capital assets $3,000,000

Other financing sources – capital leases$3,000,000

Expenditures – lease interest $ 180,000Cash $ 180,000

Expenditures – lease principal $ 942,330Cash $ 942,330

Government-wide: Would capitalize and depreciate

Chapter 5 40

Assume a grant of $100,000 is received at the beginning of the fiscal year from the federal government to operate a counseling program for troubled youths.

Until eligibility requirements for the grant have been met” by incurring expenditures for the intended purpose, as an “exchange transaction” it is reported as “Deferred Revenue”--a liability.

The entry in the special revenue fund is: Dr. Cr.

Cash $100,000 Deferred Revenue 100,000

Operating Grants

Chapter 5 41

Assume that during the year the Counseling Program expended $75,000 for costs related to youth counseling, thus meeting eligibility requirement to expend grant resources, the entries would be:

Dr. Cr.

Expenditures $75,000

Vouchers Payable 75,000

Deferred Revenues $75,000

Revenues 75,000

(This amount would also be recorded in the Revenue detail account in the Revenue subsidiary ledger.)

Operating Grants (cont’d)

Chapter 5 42

Interest and Principal on Long-term DebtInterest:

Major expenditure for many governments. Source of payments are either general revenues or

revenues dedicated for debt service revenues. The government transfers cash from general fund as

payments are made. Example: In July, the city issued $100 million in 8%

general obligation debt to finance capital improvements. The first interest payment of $4 million is due in early January 2007.

General Fund: No entry required.

Government-wide: Must accrue.Interest expense $4

Accrued interest payable $4

Chapter 5 43

Interest and Principal on Long-term Debt (cont’d)

Long-term debt: Are recorded in schedule of long-term obligations. If a principal repayment extends beyond a fiscal year,

expenditures are recognized entirely in the year the payments are due.

Example: The city issued $10 million of 20-year deep discount bonds to finance a capital project. The bonds were sold to yield 8%, at a price of $2.145 million. Interest applicable to 2007 was $171,600.

General fund: No expenditure needs to be reported. Government-wide: Would accrue.

Chapter 5 44

Interest and Principal on Long-Term DebtGASB: In governmental funds, neither interest nor principal is

accrued in advance of the year in which it is due. But it should be accrued only in the period in which they are due.

Exception: If resources to service the debt are transferred from another governmental fund, then the expenditure and the liability may be (not required to be) recognized in the debt service fund.

Government-wide statements: LT debt must be reported at face value plus or minus any

unamortized premiums or discounts. Interest must be accrued. Timings of cash payments is irrelevant to the period in

which the expense is recognized.

Chapter 5 45

Nonexchange Expenditures

GASB: Nonexchange expenditures should generally be

recognized with their revenue counterparts. Expenditure is recognized when the recipient of

the grant has satisfied all eligibility requirements. GASB standards are applicable to both modified

and full accrual statements. On the modified accrual statements, revenues must be available for expenditure before they can be recognized.

Grants would be recognized as expenses in the same period in the government-wide as in the fund statements.

Chapter 5 46

Additional Examples

Example 1: In December 2006, the city approves a $300,000 grant to a not-for profit health clinic. The funds are to be paid in 2007 out of funds budgeted for that year and are intended to support the clinic’s activities in 2007.

General Fund: In as much as the clinic cannot use the funds until 2007, the grant is subject to a time requirement. The county need not recognize either a liability or an expenditure until 2007, when the time requirement is satisfied.

Government-wide: Same.

Chapter 5 47

Examples (cont’d) Example 2: In Dec. 2006 the city awards a not-for profit

clinic $400,000 for the acquisition of emergency communications equipment. Payment is made at the time the award is announced. The clinic is permitted to use the funds upon receipt, but intends to use them in 2007.

---Purpose restrictions have no impact on the timing of either expenditure or revenue recognition. The state must recognize an expenditure as soon as it expends the funds and the county is eligible to spend them:

Governmental Fund: Grant expenditure $400,000

Cash $400,000

Government-wide: Same, but expense instead of expenditure.

Chapter 5 48

Examples (cont’d) Example 3: In Dec. 2006, the city awards a not-for profit $200,000 for the

acquisition of emergency communications equipment. The grant is to be paid as the organization incurs and documents allowable costs. In 2007 the organization submits claims for $150,000 of which the city pays $125,000. The city expects to pay the $25,000 balance of claims submitted in Jan 2008 and the $50,000 balance of the grant by June 2008.

--- The not-for profit is eligible for the award only as it incurs and documents allowable costs. In 2007, the city became eligible for $150,000 of the grant—the amount that the state should recognize as an expenditure.

General Fund: Grant expenditure $150,000

Cash $125,000Grants payable 25,000

Government-wide: Same

Chapter 5 49

Interfund Transfers

Two types of interfund activity:

Reciprocal: Equivalent of exchange transactions

Nonreciprocal: Equivalent of nonexchange transactions.

Chapter 5 50

Reciprocal Interfund Activity

Includes: Payments for purchase of goods and services at their

approximate external fair value.

Loans and repayments of loans: If repayment is expected to occur within a reasonable time period, it should be accounted as a loan receivable by the lending fund and as a payable by the borrowing fund. -If it is not expected to paid within a reasonable period

of time, it should be accounted as a nonreciprocal transfer-out by the disbursing fund and as a nonreciprocal transfer-in by the receiving fund.

Chapter 5 51

Nonreciprocal Interfund Activity

Represents transfer of cash for which goods or services of equivalent value have not been received.

GASB 34 statement: Interfund reimbursements should not be reported in

financial statements.

For instance, if the general fund paid a bill which was the responsibility of a capital project fund, it is reported only in the capital project fund (as if it paid the bill itself).

Chapter 5 52

Additional ExamplesExample 1: In December the city transferred $2 million to the debt service

fund for repayment of principal on serial bonds issued several years earlier. The payment is due in January.

General Fund: Nonreciprocal transfer out

(debt service) $2 Cash $2

Can recognize an expenditure and a liability in the debt service fund as long as payment is due within 1 month.

Cash $2Nonreciprocal transfer in $2

Debt service expenditure $2Debt service payable $2

Government-wide: No entry required. Payment of principal recorded as a reduction of a liability when paid.

Chapter 5 53

Additional Examples (cont’d)

Example 2: Consistent with its budget, the city transferred $6 million to debt service fund to accumulate resources for the eventual payment of debt.

General Fund: Nonreciprocal transfer out $6

Cash $6

Per s.16 of Interpretation No. 6, the city cannot recognize an expenditure.

Government-wide: No entry

Chapter 5 54

Government-wide statements

Presents revenues and expenses from the perspective of the entity as a whole and not of the individual funds.

Revenues and expenditures must be eliminated in order to avoid double-counting.

Chapter 5 55

Other Financing Sources and Uses

Types: Proceeds of long-term debt Proceeds from the sale of capital assets Present value of assets and liabilities

created by capital leases Payment to bond “escrow” agents who

maintain accounts for the eventual repayment of long-term obligations

Nonreciprocal transfers

Chapter 5 56

Governmental Fund Statements

Governmental fund balance sheet: presents the fund’s resources at a particular point in time.

Governmental fund operating statement: presents the net change in resources during a particular point in time.

All measurements are in accordance with GAAP.

Chapter 5 57

Summary Accrual basis recommended to the fullest extent practicable.

2 criteria must be met before revenues are recognized in

governmental funds:-Resources must be Measurable and-Available

Governmental fund expenditures are defined as decreases in net financial resources.

Expenses are outflows or consumption of overall net assets. Nonexchange transactions in the governmental fund are

accounted for symmetrically to nonexchange revenues. Grants are recognized as expenditures when all the

requirements are met.

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