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Chapter 9 Granof-5e 1

Chapter 9

Business-Type (Proprietary) Activities


Thought to Ponder: Chapter 9"Nobody wants a landfill sited anywhere near

them, including in rural areas. We've come to this realization that landfill is valuable and we can't bury things that don't need to be buried."

- JON D. JOHNSTON of the EPA, who is helping to lead the zero-waste movement in the Southeast.

NY TIMES-Oct. 20, 2009


Learning Objectives Why governments and NFPs engage in business-

type activities Distinguish between Proprietary and

Governmental activities Proprietary Fund Accounting Two types of Proprietary Funds

--Enterprise Funds--Internal Service Funds

Accounting for Insurance Activities GASB 34, special problems of reporting

proprietary funds in government-wide statements


Reasons for use: to account for governmental entity’s ongoing

(continuing) operations and activities Enhances management of activities in which

goods or services are provided on a cost-reimbursement basis (i.e. on a user charge basis.)

To compare benefits and costs of the business-type activities of a government.

Facilitates comparisons with private enterprises

Proprietary Funds


Proprietary FundsTwo types Proprietary FundsA) Enterprise funds: Provide services to the general public. Example: City of Houston’s Airports (Bush, Hobby

and Ellington Field), George R. Brown Convention Center, Combined Utility System (formerly called the water and sewer system), etc.

B) Internal service funds: Provide services to other government departments. Example: City of Houston Health Benefit and Long-

term Disability funds. Both of these services predominantly benefit governmental

units rather than the general public or businesses

Chapter 9 6Granof-5e


Proprietary Funds -Accounting CharacteristicsGASB Statement No. 20, Accounting and Financial

Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting Funds are said to be nonexpendable (or revolving) focus on determining operating net income, changes in

net assets (or cost recovery). Full accrual basis Measurement focus on all economic resources is

consistent with GASB Recognize revenues as earned and expenses as incurred. Balance sheet recognition to both capital assets and long-

term debt.


Similar to those for a for-profit entity: Statement of Net Assets (or Balance Sheet):

Assets – Liabilities = Net Assets --Three categories of Net Assets

1) Invested in capital assets, net of related debt2) Restricted Net assets3) Unrestricted Net Assets

Statement of Revenues, Expenses, and changes in Fund Net Assets:--Reconciles beginning and ending net assets

Statement of Cash Flows--Prepared in conformity with GASB standards rather than FASB standards--Include cash and cash equivalents (i.e., time deposits, marketable securities,

and other items readily convertible to cash)

Proprietary FundsRequired Financial Statements


Assets - Liabilities = Net Assets

Recall this is the same classification of net assets that is required under GASB 34.

Proprietary Funds - Accounting Equation

1) Unrestricted Assets

2) Restricted Assets(e.g., for payment of

debt service)

3) Invested in Capital Assets, Net of Related Debt


Definition: Assets whose use is restricted by contractual agreements or legal requirements

Typical examples:Customer deposits of utilities, assets set aside for repayment of

revenue bond principal, reserves for maintenance of plant, and funding of depreciation

Ideally liabilities to be paid from restricted assets should be reported separately from liabilities to be paid from unrestricted assets.

Net Assets – Restricted, should be reported in the Equity section of the Statement of Net Assets.

2) Restricted Assets


Statement of Cash FlowsRequired for proprietary funds but not governmental funds

FASB (NFPs & publicly-traded companies) vs.

GASB (Governmental entities):

FASB Statement No. 95 classifies cash transactions into: Cash flows from operating activities Cash flows from financing activities Cash flows from investing activities

GASB Statement No. 9: Cash flows from operating activities Cash flows from NON-CAPITAL financing activities Cash flows from CAPITAL & RELATED financing activities Cash flows from investing activities


A) Enterprise FundsSlides 21 - 37


Accounts for services:1) provided to the general public on a user charge basis OR2) where the governing body has determined that periodic

determination of revenues earned, expenses incurred, and/or net income is appropriate.

Possible reasons for use:--Capital maintenance, Public policy, Management

control, AccountabilityExamples: The City of Atlanta has two major and four non-major

enterprise funds. The City of New York has no enterprise funds, but has a large number of specially created public benefit corporations. On the other hand, High Point, North Carolina has six enterprise funds, and City of San Francisco has eight enterprise funds.

Enterprise Funds


Common Types of Enterprise Funds– Water and sewer (public utilities)– Gas and electric utilities– Mass Transportation systems– Airports (ex. Bush, Hobby, Ellington Field)– Ports– Toll roads and bridges (Sam Houston Tollway – Beltway 8, Harris

Cty)– Parking garages and lots (ex. Theater District parking garage)– Golf courses (Hermann Park)– Landfill facilities– Hospitals– Liquor stores– Lotteries


GASB Statement No. 34 provides guidance on business-type activities.

MUST use enterprise funds if one of the following criteria is met: 1) Activity financed solely with revenue debt instead of governmental obligation

debt. 2) Costs of providing services recovered by fees and charges 3) Pricing policy are designed to recover costs from fees and charges

Previously, GASB standards allowed proprietary funds two options: 1) Follow pronouncements of the FASB and its predecessors issued before

November 30, 1989, unless they conflict with a GASB standard* 2) Follow all FASB and predecessor standards, both those issued before and after

November 30, 1989, unless they conflict with a GASB standard * * Note that GASB standards always take priority

Accounting for Enterprise Funds


Enterprise FundsUtility Plant - Construction in Progress

Q: Should an imputed amount equivalent tointerest be capitalized if a utility’s ownfunds are used for construction?

A: Capitalizing an “equity” component ofAllowance for Funds Used During Construction (AFUDC) is permitted bothby utility regulators and the FASB.


Municipal Solid Waste Landfills(MSWLFs)

Slides 28 - 31


Accounted for either in governmental or enterprise funds If usage fees are charged then accounted for in enterprise funds.

Fees must cover ALL costs (i.e. costs incurred before, during, and afterlandfill accepts waste) Closure & Post-closure costs include:

Equipment installed and facilities constructed after the landfill stops accepting waste (e.g. gas monitoring systems, ground water monitoring wells.)

Final Cover Monitoring & Maintenance

If accounted for in ENTERPRISE FUND: Governments must report (but need not actually fund) both : Expense & Liability related to Closure & Post-Closure costs.

If accounted for in GOVERNMENTAL FUND: Liability/Expense of post closure costs reported only in government-

wide statements. No expenditure shown in Fund Statements

--“Pay-as-you-go” basis

Municipal Solid Waste Landfills


An EPA rule requires all municipal landfills to meet stringent location, design, and operating requirements to minimize the potential for environmental damage.

Operators must also provide financial assurance they can properly close landfills when full and provide post-closure ground water monitoring for 30 years after closure.

These stringent rules are designed to protect the environment from irresponsible handling of hazardous materials

Owners must estimate the current cost of hiring a qualified third-party to close the MSWLF and care for it for 30 years after closure

Current Year Liability/Expense =

(Estimated total cost x Landfill capacity)________________________________ - Amount recognized in the past

Total Landfill Capacity

Annual adjustments are made as estimates change from year to year.

Municipal Solid Waste Landfills


Government can be held accountable for pollution cleanup costs owing to a variety of circumstances. For example:

• A school district discovered mold or asbestos in one of its buildings • Toxic substances from an abandoned county dump seeped into a nearby water supply

As with landfill costs, pollution remediation costs may be accounted for in either governmental or enterprise funds.

• Governmental funds: only current outlays would be recognized as expenditures; no long-term liabilities would be recorded.

• Enterprise funds as well as government-wide stmts: estimates of costs to be incurred in the future would be reported as both expenses and offsetting liabilities.

POLLUTION REMEDIATION COSTS


Per GASB Statement No. 49 Accounting and Financial Reporting for Pollution Remediation Obligations (November 2006), the pollution remediation costs to be accounted for include those for:

Pre-cleanup activities such as site assessments, site investigations, Cleanup activities such as removal and disposal of pollutants Government oversight and enforcement-related activities Post-remediation monitoring

These costs should be estimated and recognized as an expense and liability when the government knows or has reason to believe that a site is polluted, that it will be responsible for the cleanup, and it can make reasonable estimates of the ultimate cost.

POLLUTION REMEDIATION COSTS (Cont’d)


Miscellaneous Enterprise Fund Information

Slides 35 - 38


In addition to the usual Accounts Payable and Accrued Expenses, use two special current liability accounts:1) Customers Advances for Construction

Usually up-front deposits required to be made by builders to provide all or part of the cost of connecting new structures to utility lines. May or may not be refunded in part upon completion

2) Customer Deposits Usually reported under the caption “Liabilities

Payable from Restricted Assets”

Enterprise FundsSpecial Current Liabilities


FASB Statement No. 71 Accounting for the Effects of Certain Types of Regulation issued in 1982, stipulated that revenues, expenses and resources should be recognized in accordance with the rules established by a regulator.

Key RAP definitions Original cost: The (depreciated) cost to the first owner

to place the utility plant into public use

Utility Plant Acquisition Adjustment: The difference between the purchase price of a utility plant less the net original cost of the plant on the seller’s books.

Enterprise FundsRegulatory Accounting Principles (RAP)


Enterprise Funds Segment Information

When there are multiple enterprise funds Summary operating data, including

extent of intra- governmental subsidies, should be disclosed in the notes for "major non-homogeneous enterprise funds."


B) Internal Service FundsSlides 39 - 56


Internal Service funds are an accounting device used to accumulate and allocate costs internally among the governmental entity’s various departments/units/functions.

Account for activities:-- that provide goods or services to other funds,

departments, or agencies within the same governmental unit or occasionally to other governmental units on a user-charge or cost-reimbursement basis

Primary reason for use:--to gain efficiency in the government’s operations.

Examples: The City of Houston has two internal service funds; San Francisco has four internal service funds (central shops fund, finance, corporation reproduction fund, telecommunications and information fund) whereas the City of New York has no internal service funds.

Internal Service Funds


Motor pools

Central purchasing

Storage

Issuance of supplies

Self-insurance pools

Central data processing

Printing

Common Types of Internal Service Funds


Internal Service Funds . . . . . . are accounting entities

. . . are authorized by legislative approval

. . . rarely have its resources restricted

Must follow all FASB pronouncements issued prior to Nov. 30th 1989 unless it conflicts with GASB pronouncement (like enterprise fund).

The GFOA recommends that every state or local government establish clear criteria for whether an internal fund is classified as a fund in the CAFR.

Accounting for Internal Service Funds


Accounting: Full Accrual Basis

--Revenues derived mainly from other governmental or proprietary funds. --“Billings to Departments” is the revenue account that is similar to “Sales” of a for-

profit.--Capital assets acquired by contributions or grants must be depreciated.

Revenues & expenses are closed at year-end to “Excess of Net Billings to Departments over Costs” (or “Excess of Costs over Net Billings to Departments”) rather than to Income Summary

Since the only “customer” of the internal service fund is the government itself, the activity is presented in fund financial statements, but eliminated for external facing reporting.

The major fund requirements do not apply to internal service funds because their balances are eliminated in the government-wide financial statements

Accounting for Internal Service Funds (cont.)


Pricing is set by local management or by legislative policy

Pricing objectives vary--Can cover full costs (direct and

indirect), direct costs only, or whatever management desires.

--Full cost prices do not reflect cost of providing incremental amounts of goods or services.

Pricing Policies for Internal Service Funds


Question Number One (1)

Q: Assume that one of the government’s internal service funds was for data processing services, for which the golf course was billed $30,000, all of which was classified as “contractual services” in the golf course fund. How would that amount be reported in the column for ISF? How would it be reported in the government-wide financial statements?

A: Fund Statements: Billings of ISF would be reported as a revenue of ISF and as an expense of the golf course. The related cost of providing the service would be reported as an expense of the ISF.

Government-wide: Billings would be reported ONLY as an expense of the golf course. The revenues and expenses of the ISF would be eliminated in the consolidation process.

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Pregunta Número Dos (2)

Q: ISF reported $2.7 million in depreciation, an amount that the government takes into account in establishing the rates charged to other funds. How would this charge be reflected in the government-wide statements?

A: The depreciation charges are incorporated into the amounts billed to the funds to which the ISF provide services. Therefore, in the government-wide, they would be incorporated into the expenses of the functions accounted for in those funds.

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вопрос, номер три (3)

Q: In which column on the government-wide statement of net assets—that for governmental or business-type activities—is it most likely that the assets and liabilities of the ISF would be included?

A: Unless the ISF provides services mainly to units accounted for in proprietary funds, their assets and liabilities would be reported in the column for governmental-type activities.

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Legislative bodies are sometimes reluctant to establish ISFs because they do not wish to let purchasing occur outside the budget.

Q: Is this (budget) a real concern?

A: Even if an ISF is created for central purchasing and sales of supplies, the legislative body still maintains budgetary control over the expenditures made by most departments and programs via the General Fund and special revenues funds budgets.

问题第四 (4)

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Self InsuranceSlides 51 - 53


Self-Insurance Some governments elect to self-insure their risks.

--Reduces premiums Self insurance = NO INSURANCE (no transfer of risks to

outsider.)--It simply sets aside funds to provide for possible losses based on an

actuarially determined amount.--Often a govt. that self-insures part (or all) of its risk also centralizes

its risk financing activities--Either use the GF or the ISF to account for these activities

Example: City of Juneau, Alaska has a self-insurance fund to account for the cost of administering the City and Borough’s Risk Management Program.


GASB-mandated use of an ISF GASB standards require that an ISF be used for risk management (self-

insurance) pools of a government:--The ISF should recognize claims expense and a related liability

when:1) It is probable an asset has been impaired, a liability incurred,

or a claim will be asserted AND2) Loss is estimableDisclose other loss contingencies in the notes.

Insurance department acts as an independent insurance company. Premium Payments by government to ISF:

Only a portion is reported as expenditure by the government (and revenue by the ISF).

Excess is a nonreciprocal transfer.

Self - Insurance


Duplicate reported expenses when closing books-costs and revenues are reported twice within the same set of

financial statements.

Depreciation is transferred to other governmental funds

Detract from Objectivity of Financial Statements

Obscure Fund Balance Surpluses or Deficits -surpluses/deficits can be transferred from general fund to the

internal service fund.

PROBLEMS with ISFs


Terminating an Internal Service Fund

Transfer ISF's assets to another fund which will continue same activity

Terminate activity and distribute assets in-kind to another fund or funds

Convert ISF's assets to cash and distribute cash to another fund or funds


Business-type Activities vs.

Component Units?Slides 58-60


Component Units (CU)• The main reason for discussing CU in Ch. 9 is that some cities will

carry out these activities as CU and some will do it as part of EFs. The main difference is the legal structure. CU are separate legal entities.

• Entities that are economically intertwined with the government albeit legally separate

• Criteria to determine whether a primary government (PG) is financially accountable for another government.

(1) PG appoints a voting majority of unit’s governing body(2) A majority of unit’s governing body is composed of PG’s officials(3) The PG is able to “impose its will” upon the unit(4) Unit can cause the PG financial benefits or burdens

• If it meets these criterion, then unit is a CU of PG.• Two Presentations of CU

(1) Blended – CU consolidated with PG in government-wide statements

• Presented this way if CU “provides services exclusively or almost exclusively for the city” (City of Houston CAFR)

(2) Discrete – CU shown in a separate column in government-wide statements


Proprietary funds (internal service and enterprise) are used to account for the business-type activities of a government

Accrual accounting is used for proprietary funds and the required financial statements are the same as those for a for-profit entity, except that GASB standards must be used where they apply

ISF are reported as governmental activities on the government-wide statements

Regulatory accounting terminology and principles are used by some government owned utilities.

END

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