Chapter 9Business-Type (Proprietary)

Activities

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Thought to Ponder: Chapter 9

"Nobody wants a landfill site 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

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Learning Objectives• Why governments and NFPs engage in business-

type activities• Distinguish between Proprietary and Governmental

activities• Proprietary Fund Accounting• Two types of Proprietary Fundso Enterprise Fundso Internal Service Funds

• Accounting for Insurance Activities• GASB 34, special problems of reporting proprietary

funds in government-wide statements

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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

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Proprietary Funds

Proprietary FundsTwo types of 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

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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.

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

Assets – Liabilities = Net (Assets) PositionThree categories of Net Assets1) Net Investment in capital assets (net of related debt)2) Restricted Net assets position3) Unrestricted Net Assets position

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

• Statement of Cash Flowso Prepared in conformity with GASB standards rather than FASB

standardso Include cash and cash equivalents (i.e., time deposits, marketable

securities, and other items readily convertible to cash)

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Proprietary FundsRequired Financial Statements

Assets - Liabilities = Net Position Assets

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

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Proprietary Funds - Accounting Equation

1) Unrestricted Assets

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

debt service)

3) Net Investment in Capital Assets, Net of Related Debt

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

o 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 Position Assets.

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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

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A) Enterprise Funds Cha

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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:o Capital maintenance, Public policy, Management

control, Accountability

Examples: The City of Atlanta has two major and five non-majorenterprise funds. The City of New York has no enterprise funds, buthas a large number of specially created public benefit corporations.On the other hand, High Point, North Carolina has six enterprisefunds, and City of San Francisco has eight enterprise funds (allmajor).

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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 Toll way – Beltway

8, Harris County Toll Road)• Parking garages and lots (ex. Theater District parking

garage)• Golf courses (Hermann Park)• Landfill facilities• Hospitals• Liquor stores• Lotteries

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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 charges3) 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

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Accounting for Enterprise Funds

Enterprise FundsUtility Plant - Construction in ProgressQ: Should an imputed amount equivalent to

interest be capitalized if a utility’s own funds are used for construction?

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

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Municipal Solid Waste Landfills(MSWLFs)

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

• Fees must cover ALL costs (i.e. costs incurred before, during, and after landfill accepts waste)o 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:o Governments must report (but need not actually fund) both:

Expense & Liability related to Closure & Post-Closure costs.

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

government-wide statements.o No expenditure shown in Fund Statements

--“Pay-as-you-go” basis

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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

o 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

o Current Year Liability/Expense =(Estimated total cost x Landfill capacity)________________________________ - Amount recognized in the past Total Landfill Capacity

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

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Municipal Solid Waste Landfills (Cont’d)

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.

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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.

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POLLUTION REMEDIATION COSTS (Cont’d)

Miscellaneous Enterprise Fund Information

Regulatory Accounting Practice (RAP)

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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.

What is rate of return regulation?

Why is rate of return regulation necessary?

What types of entities are subject to rate of return regulation?

What do the rates that I see on my electric utility bill mean?

How is the revenue requirement established?

What happens after the revenue requirement is established?

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Enterprise FundsRegulatory Accounting Principles (RAP)

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.

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Enterprise FundsRegulatory Accounting Principles (RAP)

In addition to the usual Accounts Payable and AccruedExpenses, use two special current liability accounts:

1) Customers Advances for ConstructionUsually 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 DepositsUsually reported under the caption “Liabilities Payable from Restricted Assets”

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Enterprise FundsSpecial Current Liabilities

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." C

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B) Internal Service Funds

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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.

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Internal Service Funds

• Central purchasing• Storage• Issuance of supplies• Self-insurance pools• Central data processing• Electronic Equipment maintenance• Printing• Transportation (ex. Motor pools)• Central Post office• Central Telephone exchange

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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.

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Accounting for Internal Service Funds

Accounting:• Full Accrual Basis

o Revenues derived mainly from other governmental or proprietary funds.

o “Billings to Departments” is the revenue account that is similar to “Sales” of a for-profit.

o 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

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Accounting for Internal Service Funds (cont’d)

• Pricing is set by local management or by legislative policy

• Pricing objectives varyo Can cover full costs (direct and indirect),

direct costs only, or whatever management desires.

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

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Pricing Policies for Internal Service Funds

Self Insurance Cha

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Self-Insurance• Some governments elect to self-insure their risks.o Reduces premiums

• Self insurance = NO INSURANCE (no transfer of risks to outsider.)o It simply sets aside funds to provide for possible losses

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

centralizes its risk financing activitieso 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.

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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 estimable Disclose other loss contingencies in the notes.

• Insurance department acts as an independent insurance company.

• Premium Payments by government to ISF: o Only a portion is reported as expenditure by the

government (and revenue by the ISF).o Excess is a nonreciprocal transfer.

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Self-Insurance (Cont’d)

• Duplicate reported expenses when closing bookso 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 o surpluses/deficits can be transferred from

general fund to the internal service fund.

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PROBLEMS with ISFs

Terminating an Internal Service Fund

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• 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

Service Concession Arrangements (SCA)GAAP is GASB Statement No. 60, “Accounting and Financial Reporting for Service Concession Arrangements.”• SCA are long-term arrangements in which a government contracts

with a private sector entity or another government to operate a major capital asset for example: toll roads, hospitals, student housing, airports, telecommunication networks etc.

• The government transfers to the contracted party the right and related obligation to provide services through the use of infrastructure or other public asset.

• In exchange the government receives from the other party an up-front payment or a series of payments over time.

• GASB standards dictate that government spread any gains from the transfer of the assets over the term of the contract.

• Governments enter into these agreements because they provide quick and easy source of cash. In essence these agreements are the economic equivalent of borrowing transactions.

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Revenue Bonds

• Revenue Bonds are backed by specific revenue streams such as dedicated taxes or user charges.

• Business-type activities of governments are often supported by revenue bonds

• Revenue Bonds are also issued by not-for-profit entities including healthcare organizations, universities and museums.

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Business-type Activities vs.

Component Units?

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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” (examples in City of Houston CAFR)

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

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• 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

• Service Concession Arrangements are long-term arrangements in which a government contracts with a private sector entity or another government to operate a major capital asset.

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Business –Type ActivitiesSummary