Accounting Question

College of Administration and Finance Sciences

Assignment (1)
Deadline: Saturday 12/10/2024 @ 23:59
Course Name: Government and NonProfit Accounting

Student’s Name:

Course Code: ACCT321

Student’s ID Number:

Semester: First

CRN:
Academic Year: 1446 H

For Instructor’s Use only
Instructor’s Name: Dr Maysoon Khoja
Students’ Grade:

/15

Level of Marks: High/Middle/Low

Instructions – PLEASE READ THEM CAREFULLY
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College of Administration and Finance Sciences

Assignment Question(s):

(Marks 15)

Question 1:

(5 Marks)

Q.1 The council of the Town of Tulia approved the 2023 budget as follows:
Budgeted 2023 revenues from:
Property taxes

$5,000,000

Sales taxes

$1,000,000

Appropriations for 2023:
Salaries

$4,600,000

Materials

$1,200,000

Equipment

$100,000

During 2023, the town’s mayor presented the council with a budget revision to increase the
amount of appropriation for salaries by $10,000. The council approved this budget revision.

Required:
a.

Prepare the general journal entry necessary to initially record the budget.

b.

Prepare the general journal entry necessary to record the budget revision.

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College of Administration and Finance Sciences

Question 2:

(5 Marks)

Q.2 Differentiate between Capital Projects Funds (CPF), Debt Service Funds (DSF)
Leased Assets and Permanent Funds.

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College of Administration and Finance Sciences

Question 3:

(5 Marks)

Q.3 Prepare journal entries to record the following transactions for a town in 2018. The Town
records encumbrances only for its Supplies appropriation.
a. The town adopted the following budget for the year:
Revenues:
Property taxes

$412,500

Licenses and fees

$52,500

Appropriations:
Salaries

$382,500

Supplies

$ 60,000
$2,250

Interest

b. Property tax bills amounting to $412,500 were sent to the property
owners.
c. Because property taxes were not due to be received for several months
and the town needed cash to finance its activities, the town borrowed
$150,000 from a local bank using tax anticipation notes.
d. The town paid salaries in the amount of $112,500.
e. The town sent out two purchase orders for supplies: purchase order A for
$9,000 and purchase order B for $7,500.
f. The town received $195,000 from property owners in payment of their
property taxes.
g. The town repaid the bank on its borrowing in transaction c. The amount
paid was $151,500, which included interest of $1,500.
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College of Administration and Finance Sciences

h. The town collected $22,500 for fishing licenses.
i. The town received the supplies ordered on purchase order A in
transaction e. All the supplies arrived in good condition and the invoice
for $9,150 was approved for payment.
j. The town Treasurer paid the invoice in transaction i for $9,150.

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Introduction
to Governmental and
Not-for-Profit
Accounting

This page intentionally left blank

Seventh Edition

Introduction
to Governmental and
Not-for-Profit
Accounting
Martin Ives
New York University (retired)

Terry K. Patton
Midwestern State University

Suesan R. Patton
UHY LLP

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Library of Congress Cataloging-in-Publication Data
Ives, Martin.
Introduction to governmental and not-for-profit accounting / Martin Ives, Terry Patton, Suesan Patton.—7th ed.
p. cm.
Rev. ed. of: Introduction to governmental and not-for-profit accounting / Martin Ives . . . [et al.]. 6th ed.
ISBN-13: 978-0-13-277601-1
ISBN-10: 0-13-277601-4
1. Fund accounting. 2. Finance, Public—Accounting. 3. Nonprofit organizations—Accounting.
I. Patton, Terry K. II. Patton, Suesan R. III. Introduction to governmental and not-for-profit
accounting. IV. Title.
HF5681.F84R39 2013
6579.835—dc23
2012020546

10 9 8 7 6 5 4 3 2 1
ISBN 10:
0-13-277601-4
ISBN 13: 978-0-13-277601-1

BRIEF CONTENTS
Chapter 1

Governmental and Not-for-Profit Accounting Environment
and Characteristics 1

Chapter 2

The Use of Funds in Governmental Accounting

Chapter 3

Budgetary Considerations in Governmental
Accounting 58

Chapter 4

The Governmental Fund Accounting Cycle: An Introduction
to General and Special Revenue Funds 100

Chapter 5

The Governmental Fund Accounting Cycle: General and
Special Revenue Funds (Continued) 127

Chapter 6

The Governmental Fund Accounting Cycle: Capital Projects
Funds, Debt Service Funds, and Permanent Funds 182

Chapter 7

The Governmental Fund Accounting Cycle: ProprietaryType Funds 228

Chapter 8

The Governmental Fund Accounting Cycle: Fiduciary
Funds 264

Chapter 9

Reporting Principles and Preparation of Fund Financial
Statements 308

Chapter 10 Government-Wide Financial Statements

15

355

Chapter 11 Federal Government Accounting and Reporting
Chapter 12 Accounting for Not-for-Profit Organizations
Chapter 13 Accounting for Health Care Organizations

398

435
487

Chapter 14 Analysis of Financial Statements and Financial
Condition 535
Chapter 15 Fundamentals of Accounting
Index

574

617

v

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CONTENTS
Preface xiii
About the Authors

xvii

Chapter 1 GOVERNMENTAL AND NOT-FOR-PROFIT ACCOUNTING
ENVIRONMENT AND CHARACTERISTICS 1
Governmental and Not-for-Profit Organizations 2
The Operating Environment 3
Users and Uses of Accounting Information 6
Objectives of Financial Reporting 7
Distinctive Accounting and Financial Reporting Characteristics 8
Accounting Principles and Standards 10
Organization of Textbook 12
Review Questions 13
Discussion Scenarios and Issues 13
Exercises 14

Chapter 2 THE USE OF FUNDS IN GOVERNMENTAL
ACCOUNTING 15
Fund Accounting 18
Measurement Focus and Basis of Accounting 21
Governmental-Type Funds 27
Proprietary-Type Funds 36
Fiduciary-Type Funds 43
Review Questions 46
Discussion Scenarios and Issues 46
Exercises 47
Problems 50

Chapter 3 BUDGETARY CONSIDERATIONS IN GOVERNMENTAL
ACCOUNTING 58
Budget Laws 60
Budgetary Types and Approaches 60
The Budget Process 63
Service Efforts and Accomplishments 70
Budgetary Review 70
The Budget Document 73
Legislative Consideration and Adoption of the Budget 73
Property Tax Levy 75
Using Budgetary Information 76
vii

viii

Contents

Classifying Revenues and Expenditures 78
Budgetary Accounting 81
Other Aspects of Budgetary Accounting 88
Review Questions 91
Discussion Scenarios and Issues 91
Exercises 92
Problems 95

Chapter 4 THE GOVERNMENTAL FUND ACCOUNTING CYCLE:
AN INTRODUCTION TO GENERAL AND SPECIAL
REVENUE FUNDS 100
Background 101
Basic Entries in General and Special Revenue Funds 104
Fund Financial Statements 111
Closing the Accounts 115
Control Accounts and Subsidiary Ledgers 116
Other Matters and Concluding Comments 117
Review Questions 118
Discussion Scenarios and Issues 118
Exercises 119
Problems 121

Chapter 5 THE GOVERNMENTAL FUND ACCOUNTING CYCLE:
GENERAL AND SPECIAL REVENUE
FUNDS (CONTINUED) 127
Recognition and Measurement—General Principles 129
Property Tax Revenues and Receivables 131
Sales Tax and Income Tax Revenues and Receivables 136
Intergovernmental Grants and Other Revenues 138
Expenditures and Fund Liabilities 141
Interfund Transactions 145
Other Accounting Matters 149
Fund Balance Presentation 151
Review of Year-end Financial Statements 155
Review Problem on the General Fund 156
Review Questions 169
Discussion Scenarios and Issues 169
Exercises 170
Problems 174
Summary Problem—Complete Accounting Cycle of General Fund 179

Contents

Chapter 6 THE GOVERNMENTAL FUND ACCOUNTING CYCLE:
CAPITAL PROJECTS FUNDS, DEBT SERVICE FUNDS,
AND PERMANENT FUNDS 182
Measurement Focus and Basis of Accounting 185
Capital Projects Funds 185
Debt Service Funds 198
Leased Assets 207
Permanent Funds 209
Concluding Comment 211
Review Questions 213
Discussion Scenarios and Issues 213
Exercises 214
Problems 217
Summary Problem 225

Chapter 7 THE GOVERNMENTAL FUND ACCOUNTING CYCLE:
PROPRIETARY-TYPE FUNDS 228
Overview 229
Specific Aspects of Internal Service Funds 231
Specific Aspects of Enterprise Funds 240
Review Questions 252
Discussion Scenarios and Issues 252
Exercises 253
Problems 255
Summary Problem 262

Chapter 8 THE GOVERNMENTAL FUND ACCOUNTING CYCLE:
FIDUCIARY FUNDS 264
Overview of Employer Government Pension and
OPEB Accounting 266
Fiduciary-Type Funds: Pension Trust Funds 273
Fiduciary-Type Funds: Investment Trust Funds 283
Fiduciary-Type Funds: Private Purpose Trust Funds 289
Fiduciary-Type Funds: Agency Funds 293
Review Questions 297
Discussion Scenarios and Issues 298
Exercises 298
Problems 302
Summary Problems 305

ix

x

Contents

Chapter 9 REPORTING PRINCIPLES AND PREPARATION OF FUND
FINANCIAL STATEMENTS 308
Financial Reporting Objectives and GASB Statement No. 34 310
The Financial Reporting Entity 312
Overview of the Comprehensive Annual Financial Report 317
Minimum External Financial Reporting Requirements 319
Preparing Management’s Discussion and Analysis 320
Preparing Fund Financial Statements: General 322
Preparing Fund Financial Statements for Governmental Funds 324
Preparing Fund Financial Statements for Proprietary Funds 329
Preparing Fund Financial Statements For Fiduciary Funds 330
Preparing Notes to the Financial Statements 331
Preparing Required Supplementary Information 333
Preparing the Statistical Section 337
Review Questions 339
Discussion Scenarios and Issues 340
Exercises 341
Problems 343
Continuing Problems 350

Chapter 10 GOVERNMENT-WIDE FINANCIAL STATEMENTS

355

Focus and Format of Government-Wide Statements 357
Preparing Government-Wide Financial Statements 368
Creating Government-Wide Financial Statements From Fund Financial
Data: Comprehensive Illustration 374
Capital Assets, Including Infrastructure Assets 385
Review Questions 388
Discussion Scenarios and Issues 389
Exercises 389
Problems 393
Continuing Problems 396

Chapter 11 FEDERAL GOVERNMENT ACCOUNTING
AND REPORTING 398
Background 399
The Federal Accounting and Financial Reporting Model 408
Recording Transactions and Events 414
Federal Agency Financial Reporting 422
Review Questions 428

Contents

Discussion Scenarios and Issues 428
Exercises 428
Problems 432

Chapter 12 ACCOUNTING FOR NOT-FOR-PROFIT
ORGANIZATIONS 435
Characteristics of Not-For-Profit Organizations 437
Financial Reporting 438
Contributions Other Than Services and Collections 444
Contributed Services 452
Contributions to Collections 453
Investments and Split-Interest Agreements 455
Other Accounting Matters 458
Fund Accounting in NFPOs 461
Illustration Using Funds 462
Review Questions 470
Discussion Scenarios and Issues 470
Exercises 470
Problems 475
Appendix 12A Not-for-ProfIt Colleges and Universities 482
Financial Statements of Not-for-Profit Colleges
and Universities 482
Notes to the Financial Statements 485

Chapter 13 ACCOUNTING FOR HEALTH CARE
ORGANIZATIONS 487
Health Care Service Providers 489
Introduction to Hospital Accounting and Financial Reporting 489
Patient Service Revenues 492
Investment Income, Other Revenues, and Gains 497
Expenses 500
Other Transactions 502
Accounting for Transactions with Restrictions When
Using Funds 504
Financial Statements 510
Review Questions 520
Discussion Scenarios and Issues 520
Exercises 521
Problems 525

xi

xii

Contents

Chapter 14 ANALYSIS OF FINANCIAL STATEMENTS AND FINANCIAL
CONDITION 535
Information Content of Financial Statements: A Financial Analysis
Perspective 537
An Approach to Financial Statement and Financial Condition
Analysis 539
Financial Statement and Financial Condition Analysis Indicators 541
Governmental Financial Condition Assessment 550
Illustration of Analysis of Governmental Financial Statements 553
Illustration of Analysis of Not-For-Profit Hospital Financial
Statements 559
Review Questions 565
Discussion Scenarios and Issues 565
Exercises 566
Problems 569

Chapter 15 FUNDAMENTALS OF ACCOUNTING

574

The Accounting Equation: Transaction Analysis 575
The Accrual Basis of Accounting 582
Recording Transactions: Debits and Credits 586
Financial Statements 599
Closing the Books 602
Other Transactions and Other Matters 604
Review Questions 607
Exercises 607
Problems 613
Index

617

PREFACE
We have had extensive experience in teaching, in working at all three levels of government, in setting accounting standards, and in auditing financial statements. We know that accounting standards have become increasingly complex in an increasingly complex world. Therefore, we wrote this
basic-level text on governmental and not-for-profit financial accounting and reporting with one key
objective: to make it easy to read and understand. To accomplish this objective, we followed this
general approach: discuss the accounting principle, show the journal entry, provide an illustration.
Given that the text is designated as an “introduction” to the subject, we tried to cover the basic
accounting and financial reporting principles in as comprehensive a manner as possible. To keep
the text practical and of the “real world,” we enhanced the discussion of the principles with numerous illustrations drawn from financial reports prepared by actual governments and not-for-profit
organizations. We updated the material to cover the latest accounting standards issued by the standards-setting bodies. Finally, we designed the end-of-chapter questions, discussion scenarios, exercises, and problems specifically to help students better understand the material covered in the text.
This text is written for college students (both accounting and public administration majors)
and for practitioners. To permit use by different types of readers, its 15 chapters cover not only the
specialized financial accounting and reporting standards applicable to the governmental and notfor-profit sectors, but also the basic processes of business-type accounting. Those who have not had
a course in basic accounting or who need a brief refresher can start with Chapter 15 (Fundamentals
of Accounting) and draw selectively on the governmental, not-for-profit, health care, and financial
statement analysis chapters. Because of its flexibility, this text can be used by all of the following:
1. Accounting majors who wish to learn the fundamentals of governmental and not-for-profit
accounting in either a full semester or less than a full semester
2. Public administration majors who have had no previous accounting training but who need
a basic understanding of general, governmental, not-for-profit, and health care accounting;
financial reporting; and financial statement analysis
3. Persons employed by governments and not-for-profit organizations, including the federal
government, health care entities, colleges and universities, and voluntary health and welfare organizations
4. Persons preparing for the Uniform Certified Public Accountant (CPA) examination, Certified Government Financial Manager (CGFM) examination, and civil service examinations
5. Persons who wish, on their own, to learn about the financial accounting and reporting
practices of governments and not-for-profit organizations

FEATURES OF THIS EDITION
Real Situations Illustrate the Application of Theory
To prepare for the practice of accounting, auditing, and financial management, students must be
able to visualize the application of accounting theory to real-world situations. In preparing this
seventh edition, we made a particular effort to increase the use of illustrations based on financial
statements issued by actual governments and not-for-profit organizations. For example,
1. Throughout the text we used the financial statements of Mt. Lebanon, Pennsylvania, a relatively small governmental entity outside Pittsburgh, to illustrate governmental transactions,
xiii

xiv

Preface

events, use of funds, and financial reporting. Mt. Lebanon is small enough to allow students to readily visualize the transactions leading to its financial statements. To show how
financial statements are used in the real world, we added our own analysis of Mt. Lebanon’s
financial position in Chapter 14.
2. To supplement the data provided by Mt. Lebanon’s statements, we used the financial statements of many other entities, both governmental and not-for-profit. For example, we used
the notes to the financial statements of the American Museum of Natural History to illustrate accounting for collections held by museums; the financial statements of New York’s
Metropolitan Transportation Authority to illustrate how various types of subsidies are
reported by governmental enterprises; and the notes to Fordham University’s financial
statements to show how colleges and universities account for some of the more complex
contributions they receive.
3. To enliven the text, we significantly increased the special feature that we call Governmental (or Not-for-Profit) Accounting in Practice. For example, our detailed discussion of the
financial status of Social Security helps illustrate the extensive amount of detail provided
in the annual financial report prepared by the United States government; and our discussion of the procedures used by Charity Navigator to assess the financial performance
of not-for-profit entities helps illustrate the nature of the data provided in not-for-profit
financial statements.
Discussion of Modified Accrual Basis of Accounting Improved
Governmental accounting is taught after students have learned the theory of accrual accounting and the journal entries needed to record accrual-related transactions and events. Because
of this, some students have difficulty grasping both the concepts underlying the modified
accrual basis/financial resources measurement focus used in governmental-type funds and the
accounting and financial reporting implications. Therefore, we completely rewrote Chapter 5
for this edition.
Chapter 5 now contains extensive discussion of why modified accrual accounting is used,
the basic principles of modified accrual accounting, and—in a Governmental Accounting in
Practice illustration—a discussion of how financial statements prepared using modified accrual
accounting can mislead the unwary reader because modified accrual does not always measure the
economic substance of transactions and events. We believe our frank coverage of the subject—and
the classroom discussion it should engender—will help the student better understand it. Chapter 5
also includes more detailed discussion of the accounting entries needed to record transactions
and events under modified accrual accounting, a comprehensive end-of-chapter illustration that
covers the entire accounting and financial reporting cycle, and many new discussion scenarios,
exercises, and problems. We also rewrote Chapter 4 to better set the stage for the material covered
in later chapters.
Text Updated for New Accounting Standards
Keeping an accounting text up-to-date can be challenging because accounting standards-setters
are invariably working on new standards while the text is being written. This edition takes
account of all standards issued by the Governmental Accounting Standards Board through GASB
Statement No. 63 and even refers to several statements and concepts statements in progress while
the text was being written. Chapter 5 of the text was updated to incorporate the requirements of

Preface

GASB Statement No. 54, which has had a major effect on fund balance reporting. All other chapters
were also updated to incorporate relevant new standards (and GASB Implementation Guides)
issued after the sixth edition of this text was prepared. We will keep instructors informed of relevant new standards through the Pearson web site.
Coverage of Other Types of Entities Expanded
Although most of this text (Chapters 2 through 10) is devoted to state and local government
accounting, we have continued to provide extensive coverage of the unique aspects of accounting
and financial reporting for the federal government and not-for-profit entities, including not-forprofit hospitals. We expanded Chapter 11 (federal government) to cite specific references to the
government’s Standard General Ledger. Exploring the citations included in this chapter will give
students greater insight into federal government finances; our new Federal Financial Reporting
in Practice provides an accounting perspective on the growth of the federal deficit.
We also added new illustrations to the material covered in the chapters on not-for-profit
organizations. All references to FASB standards and AICPA documents were changed to the
FASB’s new Accounting Standards Codification (ASC). Recognizing some of the more complex
financial instruments held by not-for-profit entities as a result of the contributions they receive,
we added a section on split-interest agreements.
Actual Financial Statements Analyzed
Accounting and public administration students need to understand not only how accounting
information is gathered and reported, but also how it is used. Therefore, we continued the chapter
on financial statement analysis (Chapter 14), which was included in previous editions. Our discussion of the principles of financial statement analysis is supplemented with our own analysis of a
real government (Mt. Lebanon) and a real hospital (unnamed). As a basis for analyzing the financial position of the hospital, we used “indicators” and “norms” taken from data on actual hospitals, available at various web sites. Our objective here was to provide the inquisitive student with
sufficient data to “do it yourself.”
Continuing Problems
This text has three “continuing problems” for instructors who like to reinforce the discussion of
accounting principles with problems that carry throughout the text. One problem, called Leisure
City, is designed to emphasize fund accounting. It starts at the end of Chapter 5 and covers fundlevel accounting and financial reporting in Chapters 5 through 8. The other two, called CoCo
City and Croton Village, also cover fund-level accounting transactions but are designed primarily
to emphasize fund-level and government-wide financial reporting. They are presented at the end
of Chapters 9 and 10 and are developed so that portions of each problem can be assigned, as
appropriate, with Chapters 2 through 10.
Ancillary Package
To assist instructors in the classroom, the solutions manual and test item file are available for
download by registered faculty at the Instructor Resource Center www.pearsonhighered.com.
Updates on new standards, prepared by the authors of this text, are also available at that site.

xv

xvi

Preface

ACKNOWLEDGMENTS
We sincerely appreciate the help of the many members of the professional community, students,
and faculty in preparing this edition and previous editions of this text. In particular, we thank the
following:
Joseph R. Razek and Gordon A. Hosch, who wrote the original text and who set the tone
for the content and presentation of the material in the subsequent editions. We have tried to continue on the path they set.
Those who assisted us in obtaining the financial statements and other material we used to
make governmental and not-for-profit accounting and financial reporting come alive. They are
Ms. Marcia Taylor, Assistant Manager of the Municipality of Mt. Lebanon, Pennsylvania, and a
member of the Governmental Accounting Standards Board, and Mr. John Lordan, Chief Financial Officer and Treasurer of Fordham University, New York. Marcia went beyond the call of duty
to answer the questions we raised to ensure that our many references to Mt. Lebanon’s financial
data were complete, accurate, and up-to-date.
Those who answered the questions we raised during the writing of this edition regarding
accounting standards and procedures. They include Mr. David Bean, Director of Research and
Technical Activities, and Mr. Kenneth Schermann, Senior Technical Advisor, of the Governmental Accounting Standards Board; and Ms. Wendy Comes, Executive Director, and Ms. Eileen
Parlow, Assistant Director, of the Federal Accounting Standards Advisory Board.
The people at Pearson, Donna Battista, Editor-in-Chief; Christina Rumbaugh, Editorial
Project Manager; Nancy Fenton, Senior Managing Editor; Clara Bartunek, Production Project
Manager.
Mr. Ives also thanks his wife, Eunice, whose encouragement in writing this text (and
reminding him when it was time to eat) helped make the project a joy. As new authors on the
book, Mr. and Mrs. Patton thank their coauthor, Mr. Ives, for his guidance and patience while
working together on the seventh edition.

ABOUT THE AUTHORS
Martin Ives, MBA, CPA (inactive), CGFM (retired), CIA, served for 16 years as Distinguished
Adjunct Professor of Public Administration at New York University’s Wagner Graduate School of
Public Service. Before entering the academic world, Mr. Ives was Vice Chair and Director of
Research of the Governmental Accounting Standards Board, First Deputy Comptroller of the
City of New York, Deputy Comptroller of the State of New York, and a member of the Federal
Accounting Standards Advisory Board.
In addition to this text, Mr. Ives is the author of the textbook Assessing Municipal Financial
Condition, coauthor of the textbook Government Performance Audit in Action, and coauthor of
Program Control and Audit and Financial Condition Analysis and Management. He has also written
chapters for books on auditing and municipal finance, has authored about 30 articles for the Journal of Government Financial Management, the Journal of Accountancy, the Internal Auditor, and
other professional journals, and has spoken to numerous professional and civic organizations.
Mr. Ives was founding president of the Albany chapter of the Institute of Internal Auditors,
president of the Capitol District Chapter of the American Society for Public Administration, and
a member of the founding board of the Association of Government Accountants’ Certified Government Financial Manager program. He has received many honors and awards, including the
Public Service Award (Fund for the City of New York); the Governor Charles Evans Hughes
Award (Capitol District chapter of the American Society for Public Administration); and the S.
Kenneth Howard Award (Association for Budgeting and Financial Management). He has also
been voted Adjunct of the Year by the students at NYU’s Wagner Graduate School.
Terry K. Patton, PhD, CPA, CGFM, is the Robert Madera Distinguished Professor of Accounting and Dean of the Dillard College of Business Administration at Midwestern State University in
Wichita Falls, Texas. He teaches governmental accounting, auditing, and accounting research and
communications. He received his Bachelor’s degree from Midwestern State University, a Master’s
degree from the University of North Texas, and a PhD from Texas Tech University.
Dr. Patton began his career in public accounting, where he audited local governments.
Later, he served as a Project Manager and as the Research Manager for the Governmental Accounting Standards Board. He has coauthored a governmental accounting book for practitioners,
Guide to Governmental Financial Reporting Model: Implementing GASBS No. 34, and another governmental accounting textbook published by Pearson Prentice Hall. He has published articles in
the Accounting Review, Accounting Horizons, the Journal of Accounting and Public Policy, and the
Journal of Public Budgeting, Accounting, and Financial Management, among others. Dr. Patton
regularly speaks to accounting professionals on state and local governmental accounting topics.
Suesan R. Patton is the National Director of Quality Initiatives for UHY LLP in Dallas, Texas, as well
as the principal author of two PPC Thomson practitioner guides on governmental accounting
and financial reporting—Preparing Governmental Financial Statements under GASBS No. 34 and
Governmental Financial Statement Illustrations and Trends. Mrs. Patton also currently serves as a
member of the Association of Government Accountants Financial Management Standards Board
and as a reviewer for the Government Finance Officers Association’s Certificate of Excellence in
Financial Reporting Program.
Most of Mrs. Patton’s career has been spent in standards-setting, beginning as a Manager
with the American Institute of CPAs Accounting Standards Division and continuing with a
15-year stint with the Governmental Accounting Standards Board as a Senior Project Manager.
She received a Bachelor of Arts degree in English Literature with a Concentration in Accounting
from the University of Cincinnati.

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Chapter 1

Governmental and Not-for-Profit
Accounting Environment
and Characteristics

Chapter Outline
Learning Objectives
Governmental and Not-for-Profit Organizations
The Operating Environment
Organizational Purposes
Sources of Revenue and Relationship with Stakeholders
Potential for Longevity
Role of the Budget and Legal Requirements
Users and Uses of Accounting Information
Objectives of Financial Reporting
State and Local Government Financial Reporting
Federal Government Financial Reporting
Not-for-Profit Organization Financial Reporting
Distinctive Accounting and Financial Reporting Characteristics
Use of Fund Accounting
Incorporation of Budgets into Accounting Systems
Measurement Focus and Basis of Accounting
Entity-Wide and Fund-Level Reporting
Financial Reporting of Restricted Resources
Accounting Principles and Standards
Establishing Generally Accepted Accounting Principles
Governmental Accounting in Practice: Establishing Standards in a Political Environment

Hierarchy of Generally Accepted Accounting Principles
Organization of Textbook
Review Questions
Discussion Scenarios and Issues
Exercises

1

2

Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

After completing this chapter, you should be able to do the following:
▪ Their distinguishing characteristics
▪ Their operating environment
▪ The needs of users of their accounting information
▪ The objectives of their financial reporting
▪ The distinctive characteristics of their accounting and financial reporting
▪ The jurisdiction of their accounting standards-setting bodies

T

he entities covered in this textbook—state and local governments, the federal government,
and not-for-profit organizations—represent a significant portion of our total economic
activity. Government consumption expenditures account for more than 20 percent of gross
domestic product, some $2.9 trillion of the $14.1 trillion of gross domestic product in 2009. But
consumption data alone do not measure total government expenditures because they exclude significant payments to individuals for Social Security, Medicare, and Medicaid. When payments to
individuals are included, total state and local government current expenditures were more than $2.0
trillion, and total federal government outlays were nearly $3.0 trillion in 2008. To give you an idea of
the financial scope of not-for-profit entities, the Internal Revenue Service reports that the total
expenses of Internal Revenue Code 501(c)(3) organizations (religious, educational, charitable, scientific, and literary entities) were $1.3 trillion in 2007.
Why is governmental and not-for-profit accounting covered separately from business enterprise accounting? In fact, many aspects of governmental accounting and most aspects of not-forprofit accounting are no different from those of business enterprise accounting. Governments and
not-for-profit entities do have some unique transactions—governments are financed primarily by
taxes, and not-for-profit entities receive significant amounts of contributions. But the answer to the
question lies deeper than that. Governmental and not-for-profit entities operate in an environment
different from that of business enterprises, and the users of their accounting data have somewhat
different information needs. For example, the legally adopted budget plays a particularly significant
role in governmental financial activities. Legal restrictions and resource-provider restrictions on the
use of resources play a greater role in governmental and not-for-profit entities than in business
enterprises. As a result, both internal accounting systems and external financial reporting for governmental and not-for-profit entity users are designed to provide certain types of data that differ
from the data reported by business enterprises.
This chapter discusses the characteristics of governmental and not-for-profit entities, the
major differences between their environments and that of business enterprises, and the distinctive
accounting and financial reporting resulting from those differences. This chapter also describes
the accounting and financial reporting standards-setting process for governmental and not-forprofit entities.

GOVERNMENTAL AND NOT-FOR-PROFIT ORGANIZATIONS
It is not always easy to distinguish among governmental, not-for-profit, and for-profit organizations.
The distinction lies less in the functions these entities perform than in the details of how the entities
are organized, governed, and financed. For example, hospitals may be for-profit, not-for-profit, or

Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

governmental organizations. A hospital is not necessarily a governmental one just because it was
financed partly with tax-exempt debt issued by a governmental agency. An entity is not necessarily a
not-for-profit one just because it was created under a state’s not-for-profit corporation law.
Governmental entities include the following:
• Federal government
• General-purpose political subdivisions (such as states, counties, cities, and towns)
• Special-purpose political subdivisions (such as school districts)
• Public corporations and bodies corporate and politic (such as state-operated toll roads and
toll bridges)
characteristics of
government
organizations

Other organizations created by governments by statute or under not-for-profit corporation
laws are governmental if they possess one or more of the following characteristics: (1) their officers
are popularly elected, or a controlling majority of their governing body is appointed or approved by
governmental officials; (2) they possess the power to enact and enforce a tax levy; (3) they hold the
power to directly issue debt whose interest is exempt from federal taxation; or (4) they face the
potential that a government might dissolve them unilaterally and assume their assets and liabilities.1
characteristics
Not-for-profit organizations exhibit certain basic characteristics that distinguish them
of non-forfrom business enterprises. Not-for-profit entities (1) receive contributions of significant amounts
profit
of resources from resource providers who do not expect equivalent value in return; (2) operate
organizations
for purposes other than to provide goods and services at a profit; and (3) lack ownership interests
like those of a business enterprise.2 As a result, not-for-profit organizations may obtain contributions and grants not normally received by business enterprises. On the other hand, not-for-profit
organizations do not engage in ownership-type transactions, such as issuing stock and paying
dividends. Four broad categories of not-for-profit organizations are discussed in this text: voluntary health and welfare organizations, health care organizations, colleges and universities, and
other not-for-profit organizations.

THE OPERATING ENVIRONMENT
Governmental and not-for-profit organizations operate in a social, legal, and political environment different from the environment of for-profit business enterprises. As a result, users of governmental and not-for-profit financial statements have somewhat different needs than do users of
business enterprise financial statements. These environmental differences have caused accounting
standards-setters to develop accounting and financial reporting requirements for governmental
and not-for-profit entities that sometimes differ from requirements for business enterprises.
The Governmental Accounting Standards Board (GASB), the accounting standards-setting
body for state and local governments, suggests that the major environmental differences between
governments and business enterprises relate to organizational purpose, sources of revenue,
potential for longevity, relationship with stakeholders, and role of the budget.3 Some of these

1

For further discussion, see American Institute of Certified Public Accountants, AICPA Audit and Accounting Guide,
Health Care Organizations (New York: AICPA, 2006), p. 2; and Martin Ives, “What Is a Government?” The Government
Accountants Journal (Spring 1994), pp. 25–33.
2
Statement of Financial Accounting Concepts No. 4, “Objectives of Financial Reporting by Nonbusiness Organizations”
(Stamford, CT: Financial Accounting Standards Board, 1980), par. 6.
3
“Why Governmental Accounting and Financial Reporting Is—and Should Be—Different,” Governmental Accounting
Standards Board (2006).

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Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

factors apply as well to differences between the environments of not-for-profit entities and business enterprises. In the discussion that follows, we combine some of these factors and add another
to show their potential consequences for accounting and financial reporting.
Organizational Purposes
Business enterprises exist to enhance the wealth of their owners. Because income is quantifiable
and can be measured in monetary terms, business enterprise financial reporting focuses primarily
on earnings and its components. A corporation might be considered an attractive investment if
its revenues have exceeded its expenses consistently, and investors can look forward to continued
growth in the bottom line.
In sharp contrast, governmental and not-for-profit entities exist to provide services to
their constituents. They generally try to accumulate a reasonable surplus of financial resources
to cushion against economic contraction and to provide for emergency needs. But these entities do not operate to maximize inflows over outflows. Indeed, if a local government were to
accumulate large operating surpluses, many taxpayers would soon complain that they were
being overtaxed.
For governmental and not-for-profit organizations, reporting whether inflows exceeded
outflows is only part of the picture. The challenge to financial reporting lies also in demonstrating accountability for the resources entrusted to these organizations. When used in the broad
sense of the term, accountability embraces not only probity and legal compliance, but also efficiency in delivering services and effectiveness in accomplishing program results. The GASB
encourages state and local governments to report on outputs (including cost per unit of service)
and outcomes (program results) to supplement their annual financial reporting. The federal government already requires federal agencies to prepare an annual Performance and Accountability
Report, which encompasses both financial and performance reporting.
Sources of Revenue and Relationship with Stakeholders
Business enterprises derive virtually all their revenues from exchange transactions, generally
involving specific products or services, between willing buyers and sellers. Governments, on the
other hand, obtain most of their revenues from taxation—wherein taxpayers involuntarily transfer resources for a basket of services that may or may not bear a direct relationship to what the
taxpayer wants or needs. Many not-for-profit entities obtain significant resources from voluntary
donors who expect no product or service in exchange, but who are nevertheless concerned with
whether their donations are achieving their intended purposes.
Taxes and donations are unique to governmental and not-for-profit entities and hence
require special accounting standards appropriate to those transactions. Equally important, the
nature of taxes and donations creates relationships with the providers of those resources that
emphasize the accountability aspects of financial reporting, discussed in the preceding section.
Financial reporting for business enterprises means reporting to owners and lenders who
can divest themselves quickly of their investments if they choose to do so. Also, for business
enterprises, accountability to their customers is direct and immediate: A consumer who doesn’t
like the product or service simply will not buy it again. In contrast, taxpayers are unlikely to be
able to move from the jurisdictions where they reside as readily as investors can sell securities,
and taxpayers may not benefit directly from the services provided by the taxes they pay. Similarly,
donors often cannot see for themselves the results of their contributions. The need for and means

Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

of demonstrating accountability take on added significance because of the nature of the relationship between these entities and their stakeholders.
Potential for Longevity
Business enterprises are at risk of going out of business for many reasons, such as global competition, emerging products, changing consumer tastes, inefficiencies, and recession. Not-for-profit
organizations face similar risks. Business enterprises may also go out of business by being bought
out by other enterprises. However, because of the power to tax and the nature of their services,
general-purpose governments rarely go out of business and are not bought and sold like business
enterprises.
As a result, governmental accounting standards-setters have tended to take a longer-term
perspective than their business enterprise counterparts in developing accounting measurements
for certain types of transactions. One notable difference concerns the standards for pensions and
other postemployment benefits.
Role of the Budget and Legal Requirements
Business enterprises are free to provide only those goods and services they believe will enhance
their profits. They usually cannot be required to provide goods and services against their will,
and if they cannot cope with the legal or social environment, they are free to leave the market.
Their spending decisions may or may not be subject to budgets, but if they are, the budgetary
amendment process is relatively simple. Commercial organizations also can borrow money when
convenient, subject only to requirements of lenders and investors.
Governmental entities, on the other hand, are required by law (constitution, charter, or
statute) to provide certain services. For example, most city charters provide for police and fire
protection. Managers cannot refuse to provide these services because of cost or because they
believe their residents do not deserve them. Indeed, local government managers often complain
about “unfunded mandates” from higher-level governments—requirements to perform specific
services without an equal amount of resources being provided.
Most of the resources obtained by governmental entities come from taxes, higher-level government grants, and borrowing. Some special-purpose governments, such as colleges and universities, also receive significant resources in the form of donor contributions. Spending decisions
made by the federal government, states, and general-purpose local governments are based on
budgets that have the force of law. Budgetary appropriations typically cannot be exceeded without specific legislative approval. Generally, resources provided by higher-level governments must
be used only for the specific purposes designated by those governments. Most governmental borrowings are constrained by law as to purpose, quantity, and timing. Amounts borrowed may be
subject to specific limits, such as value of real property in the jurisdiction. New bond issues may
require approval by the electorate or by a higher-level government.
Many not-for-profit organizations derive most of their resources from donor contributions, which may be subject to restrictions as to what they can be used for, when they can be used,
or whether they must be maintained in perpetuity. Recipient organizations are legally bound to
adhere to these donor restrictions.
Because of these factors, internal accounting for governmental and not-for-profit organizations generally focuses on the controls needed to ensure compliance with laws and donor restrictions. Accounting records and internal reports for governmental entities are designed to ensure

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Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

adherence to spending limitations contained in legally adopted budgets and other legal documents. Accounting records for not-for-profit entities are designed to ensure that purpose and
time restrictions imposed by donors are heeded. Further, external reports prepared by both governmental and not-for-profit entities are designed to inform users of the amount of available
resources that may be used without restriction for the general purposes of the entity as well as the
extent and nature of any restrictions.

USERS AND USES OF ACCOUNTING INFORMATION
Persons both internal and external to entities use accounting information. It is important to
understand that internal users of information usually can specify the kinds of information they
need to fulfill their duties. Hence, accounting systems and most reports derived from those systems are designed primarily to meet the needs of internal users. For example, governmental managers need accounting information to keep day-to-day control over spending to ensure that
amounts authorized by the budget are not exceeded and that sufficient resources will be available
to cover the full year’s operations. Managers of not-for-profit entities need accounting data to
help keep expenses in line with budgets and within limitations imposed by donors and grantors.
Managers of both governmental and not-for-profit entities need to monitor the day-to-day availability of cash. Boards of trustees require reports derived from accounting systems to help them
perform their governance responsibilities.
In establishing financial reporting standards, however, accounting standards-setters
emphasize the needs of external users—those not directly involved in the operations of the
reporting entity—because they do not have ready access to the entity’s information. The major
external users of governmental and not-for-profit entity financial reports are resource providers,
oversight bodies, and service recipients. Resource providers include taxpayers, donors and potential donors, investors and potential investors, bond-rating agencies (which provide data to investors), and grant-providing organizations, such as higher-level governments and foundations.
External oversight bodies include higher-level governments and regulatory agencies. Service
recipients include citizen advocate groups. Because of the wide array of external users of financial
reporting, the statements and related notes that comprise external reporting are often referred to
as “general purpose” reporting.
Users of governmental and not-for-profit financial reporting might seek answers to the following types of questions:
• Does the entity have sufficient financial resources to provide a reasonable cushion against
near-term revenue shortfalls caused by economic contraction?
• What is the likelihood of the entity’s ability to pay its short-term and long-term financial
obligations?
• What is the entity’s ability to continue to provide a particular level of services?
• Does the entity use its resources consistent with budgetary limitations, donor restrictions,
and legal and regulatory requirements?
• Do restrictions on use of resources appear to be reducing flexibility in meeting program goals?
• Do financial data show evidence of inefficiency, such as excessive administrative and fundraising costs or slow collection of taxes receivable?
• Is there evidence of excessive financial risk taking?
External financial reporting by governmental and not-for-profit organizations provides information to help answer these questions.

Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

OBJECTIVES OF FINANCIAL REPORTING
As previously mentioned, the GASB establishes accounting standards for state and local governments. The Federal Accounting Standards Advisory Board (FASAB) sets standards for the
federal government, and the Financial Accounting Standards Board (FASB) sets them for notfor-profit entities. All three have issued concepts statements on financial reporting objectives
for the entities in their jurisdictions. Concepts statements are not standards; instead, they
articulate the framework within which the standards are developed. The individual concepts
statements on objectives of financial reporting have both similarities and differences based on
the differing environments within which the entities operate. The governmental standardssetting bodies, in particular, emphasize the need for data to help financial report users assess
accountability.
State and Local Government Financial Reporting
The GASB statement of reporting objectives for state and local governments calls for financial
reporting to assist in fulfilling government’s duty to be publicly accountable and to help users
assess that accountability. To meet those objectives, financial reporting needs to provide data to
show whether current-year revenues were sufficient to pay for current-year services, to demonstrate whether resources were obtained and used in accordance with the legally adopted budget,
and to help users assess the entity’s service efforts, costs, and accomplishments.
In addition to helping users evaluate the entity’s operating results for the year and assess the
level of services that can be provided by the entity, financial reporting that follows GASB objectives also discloses an entity’s ability to meet its obligations as they come due. Financial reporting
should accomplish the latter objective by providing information about financial position and
condition and about physical and other nonfinancial resources with useful lives that extend
beyond the current year, and by disclosing restrictions on resources and risk of potential loss of
resources. (The GASB’s financial reporting objectives are discussed in more detail in Chapter 9.)
Federal Government Financial Reporting
FASAB objectives for federal financial reporting cover budgetary integrity, operating performance, stewardship, and systems and controls. The objectives state that financial reporting
should assist in fulfilling the government’s duty to be publicly accountable for money raised
through taxes and other means and for their expenditure in accordance with the government’s
budget. Financial reporting also should assist report users in (1) evaluating the entity’s service
efforts, costs, and accomplishments and its management of assets and liabilities; (2) assessing
the impact on the nation of the government’s operations and investments and how, as a result,
the nation’s financial condition has changed and may change in the future; and (3) understanding whether financial management systems and internal accounting and administrative controls
are adequate.
Not-for-Profit Organization Financial Reporting
The FASB’s financial reporting objectives for not-for-profit organizations focus on information
useful to present and potential resource providers, as well as other users, in making rational
decisions about allocating resources to those organizations. Such information helps in assessing
(1) the services provided by the entity and its ability to continue to provide them, (2) how the
entity’s managers discharged their stewardship responsibilities, and (3) the entity’s performance,

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Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

including its service efforts and accomplishments. Not-for-profit entities should provide information about their economic resources, obligations, net resources, restrictions on the use of
resources, and liquidity.

DISTINCTIVE ACCOUNTING AND FINANCIAL
REPORTING CHARACTERISTICS
Several characteristics of governmental and not-for-profit organization accounting and financial
reporting are unique or distinctive when compared with those of business enterprises. These
characteristics, which flow primarily from the environmental factors discussed earlier, are introduced here and described in greater detail in other chapters of this text.
Use of Fund Accounting
Fund accounting is perhaps the most distinctive feature of governmental and not-for-profit
organization accounting. Fund accounting segregates an entity’s assets, liabilities, and net assets
into separate accounting entities based on legal requirements, donor-imposed restrictions, or
special regulations. Fund accounting is a convenient control mechanism to help ensure that
resources are spent for the intended purposes—like using separate cookie jars for food, rent,
clothing, and so on.
Because each fund is a separate accounting entity, each must have a set of self-balancing accounts;
that is, the total assets of a particular fund must equal the total of its liabilities and fund balance (or net
assets or net position). Thus, the accounting records of a particular fund must identify the unique
resources of that fund and the claims to those resources, as distinguished from all other funds.
Entities that use fund accounting generally maintain a General Fund or an Unrestricted
Current Fund, whose resources can be used for any purpose designated by the governing body. In
addition, these entities use separate funds to account for the acquisition and disposition of
resources whose use is restricted in some manner (generally by law, regulation, or donor requirement) to specific purposes.
For many years, fund accounting provided the foundation both for internal accounting
control purposes and for external financial reporting by governmental and not-for-profit entities.
In response to concerns expressed by external financial reporting users about the complexity of
fund-based financial reporting, however, the reporting emphasis shifted away from funds and to
the entity as a whole. Nevertheless, general-purpose governments continue to use fund accounting for internal purposes, and the GASB requires both government-wide and fund-based reporting for external reporting purposes. The FASB does not require not-for-profit entities to use
fund-based reporting but does not preclude such reporting, provided the entity complies with the
FASB’s financial reporting requirements.
Incorporation of Budgets into Accounting Systems
A unique feature in governmental fund accounting is the use of budgetary accounts in the
accounting system for certain types of funds. Budgetary accounting is particularly pervasive in
the federal government, where budgetary and financial accounting tracks operate side by side.
State and local governments incorporate budgetary accounting to a somewhat lesser extent, but it
is nevertheless significant. The requirement for incorporating budgetary accounting into governmental fund accounting systems highlights the importance of ensuring that legally adopted budgets are not exceeded.

Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

Measurement Focus and Basis of Accounting
Business enterprises use the accrual basis of accounting, as distinguished from the cash basis of
accounting, when they prepare financial statements. Basis of accounting is a term that refers to
when assets, liabilities, revenues, and expenses are recognized as such in an entity’s financial
statements. Under the accrual basis of accounting, revenues are recognized when they are
earned, not necessarily when cash is received; and expenses are recognized when they are
incurred, not necessarily when cash is paid. Not-for-profit organizations, including not-forprofit hospitals, and the federal government also use the accrual basis of accounting in financial reporting.
State and local governments also use the accrual basis of accounting when they report on
their business-type activities. For their basic governmental functions, however, state and local
governments use a unique, hybrid-type basis of accounting called the modified accrual basis of
accounting. When using this basis of accounting, they measure only inflows and outflows of current financial resources, rather than all economic resources. The accounting implications of this
measurement method and focus are discussed in Chapters 2 through 6, and the financial reporting implications are covered in Chapters 9 and 10.
Entity-Wide and Fund-Level Reporting
Does the use of funds in governmental and not-for-profit internal accounting have a major effect
on external financial reporting? For many years, the answer to this question was yes. Recently,
however, the financial reporting focus has turned toward the entity as a whole. The change in
emphasis came about for practical reasons. Entities having many types of funds and reporting on
a fund basis often issued financial statements that looked complex and were not readily comprehensible because of the extensive details. State and local governments issued financial statements
with 10 or more columns, and many not-for-profit organizations issued statements showing each
group of funds layered one atop another in a “pancake” format.
To make financial reporting more useful, accounting standards-setters now emphasize the
need for financial reporting on the entity as a whole, specifically as follows:
• State and local governments report on two levels: a government-wide level that distinguishes only between governmental and business-type activities, and a fund level that
reports on individual funds. Although the fund-level financial statements are prepared on
the same basis of accounting used within the funds, the government-wide financial statements are prepared using the full accrual basis of accounting.
• Not-for-profit organization financial statements are required to focus on the organization
as a whole. Within those statements, the organizations need to report on three classes of net
assets: those that are unrestricted and those that are either temporarily restricted or permanently restricted by donors.
Financial Reporting of Restricted Resources
Reporting on restricted resources is much more pervasive in governmental and not-for-profit entity
financial reporting than it is in business enterprise reporting. For state and local governments, reporting by funds facilitates the reporting of restricted resources. In addition, the fund balances within
each fund must be reported in up to five classifications depicting the different levels of constraints on
the use of resources. And as previously noted, not-for-profit entities must show the extent to which
resources are unrestricted, temporarily restricted, or permanently restricted as to use.

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Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

ACCOUNTING PRINCIPLES AND STANDARDS
Rules guiding accounting and financial reporting are referred to as generally accepted accounting principles (GAAP). The American Institute of Certified Public Accountants (AICPA)
defines this term as follows:
[T]he consensus at a particular time as to which economic resources and obligations should
be recorded as assets and liabilities by financial accounting, which changes in assets and
liabilities should be recorded, when these changes should be recorded, how the assets and
liabilities and changes in them should be measured, what information should be disclosed
and how it should be disclosed, and which financial statements should be prepared.
Generally accepted accounting principles encompass the conventions, rules, and
procedures necessary to define accepted accounting practice at a particular time. The standard of “generally accepted accounting principles” includes not only broad guidelines of
general application, but also detailed practices and procedures.4
Establishing Generally Accepted Accounting Principles
The origins of GAAP can be traced back to the period just after the 1929 stock market crash, when
attempts were made to formulate accounting principles. Many criticized the earliest statement of
principles as being little more than a codification of the then-current accounting practices. Continued concerns with the way in which accounting principles were being established led to the formulation of the FASB in 1973 and then to the GASB in 1984. Seven members are appointed to each of
these bodies by the Financial Accounting Foundation (FAF), an entity whose members are
appointed by certain professional accounting and financial organizations. Advisory councils to both
the FASB and the GASB are composed of individuals representing organizations concerned with
the activities of the standards-setting bodies. The FASB–GASB structure is shown in Exhibit 1-1.
The FASB and the GASB are charged with establishing and improving standards of accounting and financial reporting within their respective areas of jurisdiction. The GASB’s jurisdiction
includes all state and local governmental entities, including government-sponsored colleges and
universities, health care providers, and utilities. The FASB establishes standards for all nongovernmental entities, including not-for-profit colleges and universities and health care providers. Under
this arrangement, it is possible for the two boards to establish different accounting and reporting
standards for similar transactions of similar entities, such as hospitals. Although this situation
occurs sometimes, the two boards cooperate with each other to keep differences to a minimum.
FAF

Financial
Accounting
Standards
Advisory
Council

FASB

GASB

Governmental
Accounting
Standards
Advisory
Council

EXHIBIT 1-1 Relationship Between the FASB, the GASB, and the FAF

4
Statement No. 4, “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises”
(New York: AICPA, 1970), pars. 137 and 138.

Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

The FASAB was established in 1990 to develop accounting standards and principles for the
federal government. Its nine members include six public (nonfederal) members and representatives of the offices of the three officials who have prime responsibility for federal accounting and
financial management—the U.S. comptroller general, the director of the Office of Management
and Budget (OMB), and the secretary of the Treasury. FASAB proposals become GAAP for federal agencies if neither the comptroller general nor the director of OMB objects.
Standards promulgated by the three boards are GAAP by virtue of the due process used by
the boards in developing them and the authority accorded them by the Code of Professional
Conduct of the AICPA. The due process used in developing the standards includes using task
forces, holding public hearings, issuing “exposure drafts” of proposals for comment by interested
parties, and carefully considering those comments before issuing the standards. Auditors may
not express unqualified opinions on financial statements that violate standards issued by the
applicable board.
Standards are identified by Statement Number and in Codifications issued by the Boards.
Individual Statements also contain the basis for the conclusions reached by the Boards. “Basis for
Conclusions” sections tend to be detailed and are helpful to the student desiring more detailed
understanding of issues underlying a particular standard as well as the matters considered by the
Board in reaching conclusions. Throughout this text, we identify applicable standards either by
Statement Number or by Codification section.

Governmental Accounting in Practice
Establishing Standards in a Political Environment
The GASB establishes accounting standards, but it has no enforcement powers. Several institutions,
however, play a major role in enforcing GASB standards, including the governments themselves, the
accounting profession, and the credit-rating agencies. Recent experience in Connecticut and Texas illustrates this point.
The state of Connecticut passed a law in the early 1990s requiring that its budget be balanced in
accordance with generally accepted accounting principles. (This is unusual because GASB standards
apply to financial reporting, not budgeting.) Each year, however, the state legislature delayed implementing the law because it chose not to raise the taxes or to cut the expenditures needed to achieve GAAP
balance. As a result, the state ran up annual deficits when measured in accordance with GAAP. Then, in
2007, the legislature passed a bill giving the state comptroller the authority to establish GAAP for financial reporting. Someone had the bright idea that, if the standards don’t fit the situation, all you need to do
is change the standards!
Governor M. Jodi Rell, deeply concerned that the bill would jeopardize Connecticut’s credit rating, promptly vetoed it. The governor felt that credit analysts and municipal bond buyers wanted to see
financial statements that followed uniform accounting standards set by an independent standards-setting
body. Right on, Madam Governor!
But not everyone thinks the way Governor Rell thinks. Some officials in Texas were bothered by
the implications of a new GASB standard that requires financial statement recognition of expenses and
liabilities for employee postemployment health care benefits. (We discuss this standard in Chapter 8.) So
Texas enacted a law in 2007 giving the state and its local governments the option to ignore the standard.
Because governments feared that auditors and creditors would take a dim view of those who chose to
ignore the standard, the state and most Texas local governments decided to follow the standard anyway.
Source: New York Times, articles by Mary Williams Walsh, May 18, June 2, and July 8, 2007.

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Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

Hierarchy of Generally Accepted Accounting Principles
As business practices and new financial instruments continue to evolve, financial statement preparers may encounter transactions not specifically addressed by their standards-setting body. To
deal with these situations, practitioners may be helped by documents issued by the staff of the
standards-setting body or by other organizations that issue relevant professional guidance. They,
therefore, need to know the relationships various sources of professional guidance have with each
other. For this reason, a hierarchy of GAAP has been established to guide financial statement
preparers and auditors for each type of entity. For example, GASB standards recognize the following hierarchy of pronouncements for state and local governments, ranked from most authoritative to least authoritative:
a. Officially established accounting principles; that is, GASB Statements and Interpretations.
These Statements and Interpretations are periodically incorporated into the GASB’s Codification of Governmental Accounting and Financial Reporting Standards.
b. GASB Technical Bulletins. Also, AICPA Industry Audit and Accounting Guides and AICPA
Statements of Position, provided they are specifically made applicable to state and local
government entities by the AICPA and cleared by the GASB.
c. AICPA Practice Bulletins, provided they are specifically made applicable to state and local
government entities and cleared by the GASB. Also, consensus positions of a group of
accountants organized by the GASB that attempts to reach consensus positions on accounting issues applicable to state and local government.
d. Implementation guides published by the GASB staff. Also, practices that are widely recognized and prevalent in state and local government.
If the accounting treatment for a transaction or event is not specified in any of the foregoing
sources, a financial statement preparer may consider other accounting literature, such as GASB
Concepts Statements; pronouncements within the GAAP hierarchy for nongovernmental entities
if not specifically made applicable by the GASB to state and local government entities; FASB Concepts Statements; FASAB Statements, Interpretations, Technical Bulletins, and Concepts Statements; AICPA Issues Papers; International Public Sector Accounting Standards of the
International Public Sector Accounting Standards Board; and certain other enumerated sources.

ORGANIZATION OF TEXTBOOK
Chapters 2 through 10 of the textbook cover state and local government accounting and financial
reporting. The chapters move from the recording of budgetary and financial accounting information to the preparation of financial statements. Chapters 2 and 3 introduce you to some of the
unique aspects of governmental accounting—the use of fund accounting, the accounting measurements used in each fund, and the way budgetary accounting is integrated into the accounting
system. Chapters 4 through 8 discuss the nature of the transactions generally encountered in each
fund and describe the applicable accounting procedures and measurements. Accounting within
the funds provides the basis for preparing fund-level financial statements, discussed in Chapter 9.
Adjustments are then made to the fund financial statements to prepare the government-wide
financial statements, discussed in Chapter 10.
Separate chapters are presented on federal government accounting (Chapter 11), not-forprofit accounting (Chapter 12), and hospital accounting (Chapter 13). Chapter 14 shows how an
analyst would review an entity’s financial statements to help draw conclusions about some of the

Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

factors that affect the financial health of governments and hospitals. Chapter 15 provides an
introduction to general accounting; it can be used as a refresher for the accounting student or as
a basic introduction to accounting for the public administration student.

Review Questions
Q1-1
Q1-2

Q1-3
Q1-4
Q1-5
Q1-6
Q1-7
Q1-8
Q1-9

Describe the characteristics that distinguish not-for-profit organizations from business enterprises.
Identify the various types of entities that constitute governmental organizations, and describe the
characteristics of other organizations that, when created by governments, are also considered to be
governmental entities.
Identify and briefly explain three major environmental characteristics of governmental and not-forprofit organizations.
Illustrate the kinds of restrictions placed by laws on the ability of governments to use resources, and
by donors on the ability of not-for-profit entities to use resources.
Who are the users of governmental and not-for-profit entity accounting information, and for what
purposes might they use that information?
List the three ways identified by the GASB in which financial reporting can help users assess governmental accountability.
List three unique characteristics of state and local governmental accounting as contrasted with business enterprise accounting.
What are the jurisdictions of the accounting standards-setting bodies: GASB, FASAB, and FASB?
Why is a hierarchy of generally accepted accounting principles needed?

Discussion Scenarios and Issues
D1-1

D1-2

D1-3

Croton Hospital was a not-for-profit entity. Because it experienced financial difficulties, the county
in which the hospital was located assumed control of Croton’s assets and liabilities. The county
executive appointed all five members of the hospital’s new board of trustees. The hospital’s chief
accountant, who was not replaced, continued to use the same accounting principles and financial
reporting used before the county takeover. Explain the position the county comptroller should take
regarding Croton’s accounting and financial reporting.
State law provides that all cash not immediately needed by school districts to finance current operations be forwarded to the counties in which the school districts are located. The law also requires
that county treasurers place these resources in a separate fund and invest them on behalf of the
school districts. Because Contra County is experiencing financial problems and to provide resources
to the county, the county treasurer tells the county administrator that he plans to invest the school
district funds in “junk bonds” yielding 9 percent interest. He will credit the “normal” rate of return
(5 percent) to the school districts and the remaining 4 percent to the county itself. Explain the position the county administrator should take on the treasurer’s proposal.
A city ordinance provides that “no money shall be spent for any purpose without the prior approval
of the city council.” In approving the budget for the year, the council had authorized spending
$1,300,000 for road maintenance. Late in the year, after the city had spent virtually the entire
$1,300,000, a major storm washed out portions of several roads leading to the elementary school.
The school was inaccessible, and the mayor wanted to enter into an emergency contract to repair
the roads. City engineers estimated that the cost of the repairs would be about $350,000. If the city
entered into such a contract, the total amount spent on road maintenance for the year would be
greater than the amount authorized. Recognizing the need for prompt action, the mayor immediately entered into the contract without seeking prior city council approval. Comment on the legal,
financial, and accounting systems implications of this scenario.

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Chapter 1 • Governmental and Not-for-Profit Accounting Environment and Characteristics

Exercises
E1-1

E1-2

E1-3

E1-4

E1-5

(Characteristics of not-for-profit and governmental entities)
The mayor of a large city approaches a group of citizens and suggests that they form an organization
to provide social, educational, and recreational programs for local youth. The group agrees and
forms an entity called the Community Youth Organization (CYO). The group also chooses a board
of directors, and the board hires an executive director and several staff members. CYO’s activities
are financed entirely by grants from the city, and many of CYO’s programs are held after school
hours in the high school. Is the CYO a not-for-profit or a government organization? Why? What
changes in characteristics would be needed to change it from one type of entity to the other?
(Accounting standards-setting bodies)
Three accountants started talking about hospitals. One said he was treated at a not-for-profit hospital, another said she was treated at a county hospital, and the third said he had just returned from
the hospital run by the U.S. Veterans Administration. They wondered why three different bodies
established accounting standards for hospitals. Give reasons for and against the existence of three
accounting standards-setting bodies.
(Accounting standards-setting procedures)
Several not-for-profit organizations use television campaigns to obtain pledges to contribute cash.
Some people think that not-for-profit entities should recognize pledges as revenues when the cash
is actually received. Others would recognize revenues when the pledges are made, subject to a provision for amounts not likely to be collected. Based on that scenario, discuss (a) the need for an
accounting standards-setting body, (b) the qualifications that members of that body should possess,
and (c) the procedures that body should adopt in establishing accounting standards.
(Objectives of financial reporting)
An objective of business enterprise financial reporting is to provide “information about an enterprise’s performance provided by measures of earnings and its components.” City governments, however, are not concerned with “earnings.” One of the financial reporting objectives cited by the GASB
regarding governments is that reporting should show whether current-year revenues were sufficient
to pay for current-year services. Based on these objectives, comment on the following assertions:
a. Accrual accounting is not necessary in governmental financial reporting.
b. Financial reporting alone is insufficient for measuring governmental performance; there is also
a need for reporting on program efficiency and effectiveness.
(Use of funds in governmental accounting)
On Election Day, the citizens of a small village voted affirmatively on the following proposition: “To
authorize the sale of $3,000,000 in bonds for the purpose of constructing a new firehouse.” The village manager then told the finance commissioner: “Put the entire proceeds from the bond sale into
the General Fund. That way, we can hire more firefighters with any proceeds from the bond sale
that were not used to build the firehouse.” Comment on the village manager’s instructions to the
finance commissioner.

Chapter 2

The Use of Funds in
Governmental Accounting

Chapter Outline
Learning Objectives
Introduction
Fund Accounting
Funds as Subdivisions of an Entity
Why Governments Use Fund Accounting
Fund Categories
Financial Reporting with the Use of Funds
Measurement Focus and Basis of Accounting
Application to Proprietary-Type and Fiduciary-Type Funds
Application to Governmental-Type Funds
Governmental Accounting in Practice: Form versus Substance in Budgeting
Governmental Accounting in Practice: Current Financial Resources versus Economic Resources

Governmental-Type Funds
The General Fund
Comparison with Business Enterprise Reporting—Operating Statement
Comparison with Business Enterprise Reporting—Balance Sheet

Special Revenue Funds
Capital Projects Funds
Debt Service Funds
Permanent Funds
Proprietary-Type Funds
Enterprise Funds
Internal Service Funds
Reporting on Proprietary-Type Funds
Fiduciary-Type Funds
Pension (and Other Employee Benefit) Trust Funds
Investment Trust Funds
Private-Purpose Trust Funds
Agency Funds
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Chapter 2 • The Use of Funds in Governmental Accounting

Reporting on Fiduciary-Type Funds
Governmental Accounting in Practice: How Many Funds Are Enough?

Review Questions
Discussion Scenarios and Issues
Exercises
Problems
After completing this chapter, you should be able to do the following:
▪ Understand the nature and purpose of fund accounting and identify the major fund categories

used in governmental accounting
▪ Compare and contrast the current financial resources measurement focus and modified

accrual basis of accounting with the economic resources measurement focus and accrual
basis of accounting
▪ Understand the relationship between governmental budgeting and accounting within
governmental-type funds
▪ Identify the fund types used within each of the major fund categories, describe the function of
each fund type, and give examples of when each fund type is used
▪ Understand the measurement focus and basis of accounting used by each fund type
▪ Identify the financial statements used by each fund type

INTRODUCTION
As noted in Chapter 1, state and local governmental accounting differs from business enterprise
accounting in three major respects. State and local governmental accounting (a) uses separate
funds to account for its financial activities, (b) focuses on flows of current financial resources and
uses a modified accrual basis of accounting in some funds, and (c) incorporates budgetary
accounts into the financial accounting system for some funds. This chapter provides an overview
of the material that will be discussed in detail in Chapters 3 through 10. We discuss the nature of
fund accounting, describe the purposes of the various funds used in state and local governmental
accounting, and introduce the concept of the current financial resources measurement focus and
modified accrual basis of accounting.
To better understand the unique aspects of state and local governmental accounting, it is
necessary to consider the types of activities performed by governments, how the activities are
financed, and how governments are organized to perform them. It is also necessary to grasp the
important role played by laws and budgets. State constitutions and statutes and local laws determine what governments do, how their activities are financed, and how they are organized. Most
day-to-day governmental activities are driven by budgets that, once enacted, have the force of law.
Accounting systems must be designed not only to help provide accountability for resources
entrusted to the government, but also to help ensure compliance with budgetary requirements
and limitations.
There are several ways to characterize governmental activities. One is to distinguish them
as either governmental, business, or fiduciary in nature. The distinction among the three lies
primarily in their purposes and in how the activities are financed.

Chapter 2 • The Use of Funds in Governmental Accounting

• Governmental-type: General-purpose governments (such as states, counties, and cities)
provide a range of basic, day-to-day services, including police and fire protection, sanitation, parks and recreation, and transportation. The operating costs of these services are
financed mostly by tax revenues, intergovernmental grants, and general fees. Capital assets
(such as buildings and roads) used in providing these services are financed primarily by
long-term borrowing, which is ultimately paid off primarily from tax revenues.
• Business-type: General-purpose and, often, special-purpose governments provide other
specific services—such as mass transit and water and electric utility services—financed not
by taxes, but instead by user fees or charges that cover both operating and capital costs.
Because of how they are financed and administered, these activities are often referred to as
business-type or proprietary-type activities.
• Fiduciary-type: Many governmental entities also perform certain fiduciary-type services,
holding segregated resources on behalf of others. For example, a government may perform
investing or tax collection services on behalf of other governments. Also, governments may
hold and invest resources on behalf of their employees and those of other governments to
pay pensions when the employees retire.
Not all governments are organized similarly, nor are their activities financed the same
way. For example, one municipality may finance its trash and garbage collection from general
tax revenues, another may create a legally separate governmental corporation to provide these
services through user charges, and a third may leave trash collection to private-sector carters.
Similarly, electricity may be provided to the citizenry through the legally constituted governmental entity, a separate specially created governmental corporation, or private enterprise. One
municipality may finance all aspects of highway maintenance through general tax revenues,
while another may impose a special gasoline tax just to finance a particular aspect of highway
maintenance. Therefore, care needs to be taken when comparing the finances of one government with those of another.
Governmental-type activities are controlled by a legally adopted budget—perhaps the single most important financial document prepared by governments. The revenue side of the budget
shows estimates of how much will be raised from each revenue source. On the spending side, the
budget both authorizes and limits how much may be spent for each activity or purpose. Internal
accounting systems are designed to, among other things, meet the needs of the central government budget manager (to help monitor actual results in relation to the budget), the departmental
budget manager (to show resources available for spending), and the cash manager (to help in
preparing day-to-day cash forecasts).
State constitutions and statutes and local ordinances generally require “balanced budgets;”
even where not specifically required, the balanced budget is the norm for prudent fiscal behavior.
But what is a balanced budget? Does it mean balanced on the accrual basis, the cash basis, or
some other basis of accounting? In fact, governmental budgets tend to be balanced more on the
cash basis than the accrual basis of accounting. Terms like expenditures are not defined in the
laws, and major obligations resulting from current-year activities may not be financed fully in the
budget. Some balanced budget laws permit current-year operations to be financed with longterm borrowing. As a result, governmental budgets may be balanced in form, but not in economic substance. (See the box “Form versus Substance in Budgeting” later in this chapter.) If the
accounting system needs to be responsive to budgetary needs, what are the accounting measurement and financial reporting implications of budgetary practices? This is one of the issues discussed here and in later chapters.

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Chapter 2 • The Use of Funds in Governmental Accounting

FUND ACCOUNTING
Funds as Subdivisions of an Entity
You are already familiar with the entity concept. As you know, the reporting entity defines the
boundaries of a particular financial reporting unit by describing whose assets, liabilities, revenues, expenses, and equities are included in its financial report. If a parent corporate business
enterprise exercises control over its legally separate subsidiaries, the financial activities of all
those units are consolidated for financial reporting purposes.
Although it is defined in a somewhat different manner, this notion of reporting entity
applies as well to state and local governments. New York City’s 2010 financial report, for example,
covered not only the activities of the legally constituted government of New York City, but also
the activities of about 20 separate legal organizations (such as the Health and Hospitals Corporation) for which New York City is financially accountable. In this context, New York City is called
the primary government; its constituent legally separate entities, which are public authorities or
public benefit corporations, are called component units. We will return to this aspect of the reporting entity in Chapter 9.
In state and local governmental accounting, however, there is an additional dimension to
the reporting entity. For internal accounting purposes, the primary government itself is disaggregated—subdivided—into separate fiscal and accounting entities, called funds. Each fund
accounts for particular assets, liabilities, net assets, and inflows and outflows of resources. Funds
are the basic building blocks of governmental accounting and financial reporting.
The formal definition of a fund is:
. . . a fiscal and accounting entity with a self-balancing set of accounts recording cash and
other financial resources, together with all related liabilities and residual equities or balances, and changes therein, which are segregated for the purpose of carrying on specific
activities or attaining certain objectives in accordance with special regulations, restrictions
or limitations.1
In this definition, the term fiscal entity refers to the separate budgetary nature of funds that
have only spendable financial resources, and the term accounting entity refers to a separate unit
that is treated as an entity for accounting purposes. Some types of funds also have capital assets.
The accounting equation within the funds is similar to that used in commercial accounting. In the absence of owners’ equity, however, the equity aspect of the governmental accounting
equation becomes either fund balance or net position, depending on the type of fund involved.
Why Governments Use Fund Accounting
Governmental entities must comply with legal requirements set forth in constitutions, city charters, statutes, local ordinances, and so forth. Because their day-to-day activities are guided by
budgets proposed by the executive branch and enacted into law by the legislative branch, internal
accounting systems are needed to ensure compliance with budgetary spending limits. Funds have
traditionally provided a basic control mechanism for ensuring compliance with legal restrictions
on the use of governmental resources. Indeed, most funds are established based on specific legal
requirements.
1

GASB Codification of Governmental Accounting and Financial Reporting Standards (GASB Cod.) Sec. 1300, “Statement of
Principle—Fund Accounting Systems” (Norwalk, CT: GASB, 2010).

Chapter 2 • The Use of Funds in Governmental Accounting

To illustrate, if the legislature wants to segregate gasoline taxes from other revenues to
ensure a steady flow of resources that can be used only to repair roads, it may establish a dedicated fund to record receipt of the taxes and their subsequent expenditure. If the citizens vote to
approve a bond issue for a new firehouse, segregating the bond proceeds in a dedicated fund
helps ensure that the proceeds are used for no other purpose. If the legislature wishes to demonstrate its intent to dedicate resources to the repayment of the debt, it may create a fund for that
purpose. A dedicated pension trust fund that accumulates employer and employee contributions
and the related earnings helps ensure that the resources will be used to pay pension benefits when
employees retire.
Is fund accounting absolutely necessary? Not to the extent it is used in practice. Many governments can readily accomplish the purposes of fund accounting by establishing separate
accounts for restricted resources within a single accounting and fiscal entity. In fact, there is no
consistency among governments in the extent to which they create funds. Some governments use
many more funds than others, even though they perform the same functions. Further, excessive
use of funds—for example, earmarking a particular type of tax to finance one purpose, a particular fee for another purpose, and so on—is considered a poor financial management practice
because it reduces a government’s flexibility in providing for citizen needs as priorities change.
Finally, fund accounting provides no absolute assurance that dedicated resources will be used
only for authorized purposes—a simple coding error can result in a charge to the wrong fund;
hence, we used the phrase “helps ensure” in the preceding paragraph.
On the other hand, some governments are quite complex because they are engaged in various business-type activities. Creating separate funds (and legally separate component units) helps
provide the control mechanisms, the financing tools, and the administrative structures needed to
manage those activities.
Fund Categories
As noted earlier, the activities performed by governments can be categorized as either governmental, business (or proprietary), or fiduciary, depending on their purpose and/or how they are
financed. The funds used by state and local governments can be similarly categorized. Within
each category are several specific fund types. The categories are described next, and the fund types
within each category are described later. As we will see in the next section, there is a major difference between the accounting measurements made in the governmental fund category and those
in the other two fund categories.
Governmental-type funds are used to account for most of the day-to-day public services
provided by state and local governments. Depending on the type of government, these services
may include public safety (policing and fire suppression), elementary and secondary education,
health and mental health, sanitation, environmental protection, parks and recreation, transportation, and so forth. Governments finance these services primarily by levying taxes on various
revenue bases, such as real property values, general sales and specific types of sales (such as
cigarettes and motor fuel), and personal incomes. They may also receive grants from other levels
of government in addition to other revenues such as fines, fees, investment income, and concession income.
Capital assets used to provide these services (such as police stations and office buildings)
are often financed through the proceeds of debt, which are accounted for in a separate governmental-type fund. To repay the debt sold to finance capital assets, funds are accumulated, primarily from tax revenues, in yet another governmental-type fund.

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Chapter 2 • The Use of Funds in Governmental Accounting

One of the characteristics of governmental-type funds is that their expenditures are likely
to be controlled by budgets proposed by the executive branch of government and legally adopted
by the legislative branch in the form of appropriations—authorizations to spend. The way governments prepare budgets and the legal status afforded them profoundly affect accounting within the
governmental-type funds, as we shall see in the next section of this chapter and in later chapters.
Although well-run governments do long-range planning, their annual budgets for day-to-day
operations are short run in nature. They generally cover activities for only one year.
Proprietary-type (or business-type) funds are used to account for governmental activities
that operate in a manner similar to that of private-sector businesses in the sense that they charge
fees for services and measure whether their revenues will cover their expenses. Examples of such
activities are municipal hospitals, electric and water utilities, mass transit facilities, lotteries, and
central motor pools. Many of these activities are self-supporting because their fees are sufficient
to cover their costs. Others (such as mass transit facilities) may receive subsidies from their parent government, while some (such as lotteries) provide net revenues for the parent. When these
business-type activities are performed by agencies within the legally constituted government, a
separate proprietary fund is established. When the activities are performed by legally separate
component units, these entities use what is called “proprietary fund accounting.”
Fiduciary-type funds are used to account for resources that governments hold in a trust
or agency capacity for others. “Others” might be individuals, other governments, or private
organizations. Because they are held for others, the resources in these funds cannot be used to
support the government’s own programs. Examples of situations in which a government might
be acting in a trust or agency capacity include investment pools operated by a sponsoring government on behalf of other governments and sales taxes collected by a state on behalf of county
and city governments.
Financial Reporting with the Use of Funds
External financial reporting is guided by the requirements of GASB Statement No. 34, “Basic
Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments” (1999), as amended. GASB Statement No. 34 requires two sets of financial statements, fund statements and government-wide statements. Two sets of statements are prepared
for several reasons:
• The measurement focus and basis of accounting used in the governmental-type fund category is different from that in the other two categories, as discussed in the next section.
• The information provided by the fund statements for the governmental-type fund category
is incomplete (and may be misleading because it is incomplete).
• While reporting on each fund serves a purpose, there is also a need for an overview of the
finances of the government as a whole.
The fund set of financial statements consists of three groupings—by fund category—of
individual sets of statements prepared for each fund. For the governmental-type fund category,
the statements report resource inflows and outflows (which we will sometimes refer to as “operating statements”) and financial position (balance sheets). Financial statements for proprietarytype funds are operating statements, statements of net position, and statements of cash flows.
Statements of net position and changes in net position are prepared for fiduciary-type funds.
The government-wide set of financial statements consolidates the individual funds into
two groups of activities, governmental- and business-type. In preparing the government-wide

Chapter 2 • The Use of Funds in Governmental Accounting

statements, adjustments are made to the fund statements so that all activities use the same measurement focus and basis of accounting. In addition, the fiduciary-type funds are excluded from
the consolidation because they do not support the government’s own programs. (As you read
Chapters 4, 5, and 6, keep in mind that certain adjustments will be needed to prepare the government-wide financial statements.) Chapters 9 and 10 describe how the financial statements
are prepared.

MEASUREMENT FOCUS AND BASIS OF ACCOUNTING
In addition to the use of funds, another distinctive fea…
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