CHAPTER 2
STATE AND LOCAL GOVERNMENT ACCOUNTING AND
FINANCIAL REPORTING MODEL: THE FOUNDATION
ANSWERS TO QUESTIONS
Question 2-1
Governments operate in a different environment than businesses. Governments must comply with
the many finance-related legal and contractual requirements, regulations, restrictions, and
agreements that affect their financial management and accounting. Such compliance must be
demonstrable and be reported regularly. Governments should also prepare financial statements in
conformity with generally accepted accounting principles (GAAP), which provide uniform
minimum national standards of and guidelines for annual financial reporting to groups and persons
outside the government. Therefore, one fundamental feature of a government’s accounting system is
that it must maintain and provide information that accomplishes multiple purposes.
Whereas business accounting systems must provide data both for GAAP reporting and for
income tax reporting, governmental accounting systems must provide data both for external
reporting in conformity with GAAP and for controlling and reporting on finance-related legal
compliance matters. This necessitates having different accounting systems for businesses and
governments.
Question 2-2
The measurement focus for the three fund categories are:
1. Proprietary Funds—economic resources (revenues and expenses) measurement focus,
which is the measurement focus used by business enterprises.
2. Governmental Funds—the current financial resources measurement focus.
3. Fiduciary Funds—the same measurement focus as proprietary funds—the economic
resources measurement focus.
An economic resources measurement focus results in accounting for all assets—both current and
noncurrent—and all liabilities—both current and long-term. A current financial resources
measurement focus results in accounting for financial assets and related liabilities. Noncurrent assets
and long-term liabilities are not reported under a current financial resources measurement focus.
The GASB’s approach to each measurement focus also includes two financial statement
elements not found in accounting for other types of entities—deferred outflows of resources and
deferred inflows of resources. These elements arise from changes in net assets that the GASB has
determined should not be reflected as changes in fund balance (governmental funds) or net position
(proprietary funds and fiduciary funds) until a future period.
Question 2-3
For governmental funds:
1. Revenues must be (1) “available”—collectible within the period or soon enough thereafter
to be used to pay for the expenditure liabilities incurred during the period, as well as levied
or earned—and (2) measurable to be recognized.
2. Expenditures are financial assets expended during a period for current operations, capital
outlay, and debt service including (a) long-term debt principal retirement and (b) interest on
both short-term and long-term indebtedness.
For proprietary funds:
1. Revenues are recognized when earned and measurable. There is no “availability” criterion
for revenues recognized in proprietary funds.
2. Expenses are costs consumed or expired during a period.
Difficulty: 1
Learning Objective: 2
AACSB: Reflective thinking
Question 2-4
General capital assets are not considered appropriable resources and unmatured general long-term
liabilities are not current liabilities. Hence, these assets and liabilities would not appropriately be
accounted for within a municipality’s governmental (expendable) funds, which are net current
financial resource entities. Further, general capital assets are considered to belong to the government
as a whole, not to a particular department or enterprise; and unmatured general long-term liabilities
are likewise considered obligations of the government, not of a specific fund. Thus, neither fits into
the existing fund structure of state and local governmental accounting, and both are accounted for
through the General Capital Assets and General Long-Term Liabilities nonfund accounts. They are
reported only in the government-wide financial statements.
Question 2-5
Capital assets and long-term liabilities are accounted for in:
General Capital Assets and General Long-Term Liabilities accounts
Enterprise Funds
Internal Service Funds
Trust Funds (some)
Question 2-5 (continued)
General capital assets and general long-term liabilities are accounted for in the General Capital
Assets and General Long-Term Liabilities accounts. They are related to general government
(governmental) activities.
Question 2-6
A Special Revenue Fund should be used to account for and report the proceeds of specific revenue
sources that are restricted or committed to expenditure for specified general government purposes
other than debt service or capital projects.
A Capital Projects Fund should be used to account for and report financial resources that are
restricted, committed, or assigned to expenditure for general government capital outlays, including
the acquisition or construction of capital facilities and other capital assets.
A Debt Service Fund should be used to account for and report financial resources that are restricted,
committed, or assigned to expenditure for principal and interest on general long-term liabilities.
Question 2-7
Proprietary funds include Enterprise Funds and Internal Service Funds. Proprietary fund financial
statements include a balance sheet (statement of net position), statement of revenues, expenses, and
changes in fund net position, and statement of cash flows.
Question 2-8
Governmental funds include the General Fund, Special Revenue Funds, Capital Projects Funds, Debt
Service Funds, and Permanent Funds. Governmental fund financial statements include a balance
sheet, statement of revenues, expenditures, and changes in fund balance (GAAP basis), and
statement of revenues, expenditures, and changes in fund balance – budget and actual (on the
budgetary basis of accounting).
Question 2-9
Fiduciary funds include Private-Purpose Trust Funds, Investment Trust Funds, Pension Trust Funds,
and Agency Funds. Trust fund financial statements include a statement of net position and a
statement of changes in fiduciary net position. Agency Fund financial statements include a statement
of net position and a statement of changes in agency fund assets and liabilities. (The latter is required
in a comprehensive annual financial report but not in the basic financial statements)
Question 2-10
One only: General Fund and General Capital Assets and General Long-Term Liabilities accounts
One, none, or many—all other fund types:
Special Revenue Funds Internal Service Funds Private-Purpose Trust Funds
Capital Projects Funds Enterprise Funds Investment Trust Funds
Debt Service Funds Pension Trust Funds
Permanent Funds Agency Funds
Question 2-11
Interfund loans are amounts provided by one fund to another with a requirement for and
expectation of repayment. Interfund loans are the only type of interfund transaction that initially
affects only balance sheet accounts. Because interfund loans are expected to be repaid, a loan is
reported as a receivable (asset) in the lending fund and as a payable (liability) in the debtor fund.
Neither fund balance nor net position of any fund changes because of an interfund loan—whether it
is a short-term loan or a long-term loan.
Interfund transfers are flows of assets (such as cash or goods) from one fund to another without
equivalent flows of assets or services in return and without a requirement for repayment.
• In governmental funds, transfers should be reported as other [nonexpenditure] financing uses
in the funds making transfers and as other [nonrevenue] financing sources in the funds
receiving transfers.
• In proprietary funds, transfers should be reported as the last item before the subtotal for changes
in net position.
Question 2-12
The Basic Financial Statements, which must be accompanied by Management’s Discussion and
Analysis and certain other required supplementary information, include the government-wide
financial statements (Statement of Net Position and Statement of Activities), the three sets of fund
financial statements (governmental funds financial statements, proprietary funds financial
statements, and fiduciary funds financial statements), and the related notes. The Comprehensive
Annual Financial Report (CAFR) of a governmental unit includes the basic financial statements and
is much more extensive. A CAFR contains:
1. Introductory materials e.g., letter(s) of transmittal,
2. Management’s Discussion and Analysis,
3. Basic Financial Statements and notes as well other required supplementary information,
Question 2-12 (continued)
4. Combining financial statements (for nonmajor governmental funds, nonmajor Enterprise
Funds, Internal Service Funds, Trust Funds, and Agency Funds—if there are two or more
funds in these categories. These are a minimum. Other combining statements may be
presented.),
5. Individual fund financial statements and schedules (where appropriate),
6. Narrative explanations (notes for combining or individual fund financial statements), and
7. Statistical section.
Items 2 through 6, including the auditor’s report, are called the financial section of a CAFR.
Question 2-13
Government-wide financial statements are prepared using the same measurement focus and basis of
accounting that is used for proprietary funds—the economic resources measurement focus and the
accrual basis of accounting.
Question 2-14
The accounting equation for a governmental fund is:
(Financial Assets + Deferred Outflows) – (Related Liabilities + Deferred Inflows) = Fund Balance
Question 2-15
The accounting equation for a proprietary fund is:
Assets + Deferred Outflows − Liabilities − Deferred Inflows = Net Position
Question 2-16
Deferred outflows and deferred inflows result from delaying operating statement recognition of
certain changes in the net amount of assets less liabilities. The GASB requires these changes to be
classified as deferred outflows instead of assets (or as deferred inflows instead of liabilities) when
the GASB views the change as related to future periods. (Some recent deferred outflows and
deferred inflows—e.g., proprietary fund and government-wide deferred outflows and deferred
inflow related to pensions and other postemployment benefits—appear to result more from
smoothing of the expense measurement than from being related to future periods
Question 2-16 (continued)
Deferred outflows are reported similarly to assets, and changes in deferred outflows affect the
operating statement in essentially the same way as changes in assets. Likewise, deferred inflows are
reported similarly to liabilities, and changes in deferred inflows affect the operating statement in
essentially the same manner as changes in liabilities.
Question 2-17
The primary characteristic that distinguishes Enterprise Funds from Internal Service Funds is who
the “customers” are. Enterprise Funds serve primarily individuals and organizations separate from
the government. Internal Service Funds serve predominantly other departments and agencies of the
government itself.
The primary distinction of a Special Revenue Fund compared to the General Fund is that a Special
Revenue Fund’s resources are to be used for a specified purpose(s), whereas most General Fund
resources are available for any legitimate need of the government. A Special Revenue Fund is
required to have a revenue source that is either restricted or committed to the specified purposes of
the fund as opposed to only resources provided to that fund at the discretion of the government. The
other governmental funds are not required to have such a revenue source to serve as the foundation
of the fund.
Question 2-18
The General Fund is always a major fund. In addition, any other governmental fund or Enterprise
Fund that meets both of the following “size” criteria must be reported as a major fund. The
quantitative major fund criteria are:
1. Total assets, liabilities, revenues, or expenditures/expenses (excluding extraordinary items)
of that individual governmental fund or Enterprise Fund are at least 10% of the
corresponding total (assets, liabilities, revenues, or expenditures/expenses) for all funds of
that category or type (i.e., total governmental funds or total Enterprise Funds).
2. The same element that met the 10% criterion in (a) is at least 5% of the corresponding
element total for all governmental funds and Enterprise Funds combined.
A governmental fund or Enterprise Fund that does not meet the size criteria may still be treated as a
major fund if the government deems it of sufficient importance to statement users. Thus, a
government must identify as a major fund each governmental fund or Enterprise Fund for which
statement users are likely to need individual fund information.
SOLUTIONS TO EXERCISES
Exercise 2-1
1. a
2. b
3. d
4. a
5. b
6. d
7. c
8. d
9. a
10. d
Exercise 2-2
1. b
2. c
3. a
4. d
5. b
6. c
7. c
8. c
9. a
10. c
Exercise 2-3
1. Special Revenue Fund
2. Capital Projects Fund
3. Enterprise Fund
4. General Fund
5. General Capital Assets and General Long-Term Liabilities nonfund accounts
6. General Capital Assets and General Long-Term Liabilities nonfund accounts
7. General Capital Assets and General Long-Term Liabilities nonfund accounts*
8. Debt Service Fund
9. Enterprise Fund
10. Internal Service Fund
*General long-term liabilities do not become governmental fund liabilities until the period in which
they mature.
Exercise 2-4
a. Special Revenue
b. Debt Service
c. Capital Projects
d. Special Revenue
e. Internal Service
f. Enterprise, if criteria met; otherwise Special Revenue if the revenues are restricted or
committed, or General Fund if the revenues are not restricted or committed
g. Agency
h. General
i. Enterprise
j. Capital Projects
k. Debt Service
l. Permanent
m. Capital Projects
n. Pension Trust
Exercise 2-5
a, b, c, and d
Exercise 2-6
Name of Government
Governmental Fund
Statement of Revenues, Expenditures, and Changes in Fund Balances
Time Period Report Covers
Revenues (by source) c
Expenditures (by function) d, e, f, g, h
Excess (Deficiency) of Revenues Over (Under) Expenditures
Other Financing Sources (Uses) a, (b)
Special and Extraordinary Items* j
Net Change in Fund Balance
Fund Balance (Total), Beginning
Fund Balance (Total), Ending
*The amounts reported for special items and extraordinary items would be proceeds received or
expenditures incurred for those items, not gains and losses.
Note: Depreciation expense (i) is not recorded in this statement.
Exercise 2-7
Name of Government
Proprietary Fund
Statement of Revenues, Expenses, and Changes in Net Position
Time Period Report Covers
Operating revenues (by source) c
Total operating revenues
Operating expenses (detailed) d, i
Total operating expenses
Operating income
Nonoperating revenues and
expenses (detailed) h, k
Income before capital contributions, special and extraordinary items, and transfers
Capital contributions
Special and extraordinary
items (detailed) e, j
Transfers b
Increase (decrease) in net position
Net position—beginning of period
Net position—end of period
Note: Proceeds from issuing bonds (a), Expenditures for purchases of equipment (f), and
Expenditures for principal retirement of long-term liabilities (g) are not reported in this statemen
Exercise 2-8
Name of Government
Governmental Fund
Balance Sheet
Fiscal Year End
Assets a, d, g
Liabilities, and fund balance
Liabilities j
Fund balance c, i
Total liabilities and fund balance
Note: Unrestricted net position (b), Land (e), Bonds payable (f), Current portion of bonds payable
(h), and Buildings and equipment (k) are not reported in this statement.
Exercise 2-9
Name of Government
Proprietary Fund
Statement of Net Position
Fiscal Year End
Assets
Current Assets: a, d, g
Noncurrent Assets:
Capital Assets e, k
Total Assets
Liabilities
Current liabilities h, j
Noncurrent liabilities f
Total liabilities
Net Position b
Total net position
Note: Nonspendable fund balance (c) and Unassigned fund balance (i) are not reported in this
statement.
Exercise 2-10
(1) Proprietary fund
Analysis of Transactions for Business-Type Activities
Proprietary Funds
CA + NCA – CL – LTL = NP
a. ($5,100) $200 ($5,300)
b. 3,000 3,000
c1. 2,000 2,000
c2. 150 (150)
d. (2,200) (2,150) (50)
e. 200 $200
f. 1,000 $1,000
g. (100) (100)
h. (800) (800)
i. (900) $900
j. (280) (280)
k. 35 (60) (25)
*Calculations for:
c2. Interest accrual at year end, $2,000 x .10 x 9/12 = $150
d. Liability reduction equals principal of $2000 plus accrued interest payable of $150.
k. Capital asset carrying value at disposal equals $60 (cost of $900 less accumulated depreciation
after three years of $840). Proprietary fund loss on sale of the capital asset is $35 (proceeds) less
$60 (carrying value) or $25.
Exercise 2-10 (continued)
(2) Governmental fund and nonfund accounts
7 Analysis of Transactions for General Government Activities
Governmental Funds
General Capital Assets and General
Long-Term Liabilities Nonfund
Accounts
FA – RL = FB GCA – GLTL = NP
a. ($5,100) $200 ($5,300)
b. 3,000 3,000
c1 2,000 2,000
c2. 150 (150)
d. (2,200) (2,150) (50)
e. 200 200
f. 1,000 1,000 $1,000 ($1,000)
g. (100) (100)
h. (800) (800) (800) 800
i. (900) (900) $900 900
j. (280) (280)
k. 35 35 (60) (60)
Legend
Proprietary Funds
Governmental Fund;
General Capital Assets and
General Long-Term Liabilities Nonfund
Accounts
CA Current Assets
CL Current Liabilities
LTL Long-Term Liabilities
NP Net Position
NCA Noncurrent Assets
(including capital assets)
FA Financial Assets
RL Related Liabilities
FB Fund Balance
GCA General Capital Assets
GLTL General Long-Term Liabilities
NP Net Position
