Chapter 1 – Introduction to Accounting and Financial Reporting for Governmental and Not-for-Profit Entities
Governmental and not-for-profit organizations are vast in number and range of services provided. In the United States, governments exist at the federal, state, and local levels and serve a wide variety of functions.
Governmental entities – Involuntary Taxes are the primary revenue source
States, counties, municipalities (for example, cities, towns, and villages), and townships are general purpose governments—governments that provide a wide range of services to their residents (such as police and fire protection; sanitation; construction and maintenance of streets, roads, and bridges; and culture and recreation).
Independent school districts, public colleges and universities, and special districts are special purpose governments—governments that provide only a single function or a limited number of functions (such as education, drainage and flood control, irrigation, soil and water conservation, fire protection, and water supply). Special purpose governments have the power to levy and collect taxes and to raise revenues from other sources as provided by state laws to finance the services they provide. Public colleges and universities are another example.
Not for Profit – Voluntary Donations are the primary revenue source
Not-for-profit organizations also exist in many forms and serve many different functions in society. These include private colleges and universities, various kinds of community service and health care organizations, certain libraries and museums, professional and trade associations, fraternal and social organizations, and religious organizations.
What body governs the accounting rules and reporting for government and not-for-profit entities?
The Financial Accounting Standards Board (FASB) recognizes that government and not-for-profit entities
- do not have owners who expect a return on their investment. Resource providers to these entities do not expect to be repaid or to receive economic benefits in proportion to the resources provided.
- do not operate to make a profit on goods or services provided.
- business entities do have owners whose interests can be transferred to others and who expect a share of the profits from operating the business and a residual distribution of the net assets in the case of liquidation of the organization
These entities are classified as:
State and Local
Governmental not for profits
Nongovernmental not for profits
Federal Government – Various federal agencies
Federal statutes assign responsibility for establishing and maintaining a sound financial structure for the federal government to three officials: the Comptroller General, the Director of the Office of Management and Budget, and the Secretary of the Treasury. In 1990, these three officials created the Federal Accounting Standards Advisory Board (FASAB) to recommend accounting principles and standards for the federal government and its agencies and should be consistent with those principles established by GASB and FASB. (Our focus this semester will be on state and local governments but we will learn about not for profits and hospitals).
The focus of the reporting is to both external and internal users. The Federal Accounting Standards Advisory Board (FASAB) has identified users who are both internal and external to the government: citizens, the Congress, executives, and program managers. Not surprisingly, then, its standards address both internal and external financial information needs.
State and Local Governments and Governmental Not For Profits – GASB
GASB stresses governments exist in an environment in which the power ultimately rests in the hands of the people.
Constraints are imposed on state and local governments by the federal government. In the United States higher levels of government encourage or dictate activities of lower level governments and finance the activities (partially) by an extensive system of intergovernmental grants and subsidies that require the lower levels to be accountable to the entity providing the resources, as well as to the citizenry.
Taxpayers are required to provide resources to governments even though they often have little choice about which government services they receive and the extent to which they receive them. The cornerstone of GASB reporting focus is accountability. Citizens pay individually but often have little say individually.
This relative lack of taxpayer choice is also identified in a GASB white paper that notes that “most governments do not operate in a competitive marketplace, face virtually no threat of liquidation, and do not have equity owners.” The white paper further states:
Governmental accounting and financial reporting standards aim to address [the] need for public accountability information by helping stakeholders assess how public resources were acquired and either used during the period or are expected to be used. Such reporting also helps users to assess whether current resources were sufficient to meet current service costs (or whether some costs were shifted to future taxpayers) and whether the government’s ability to provide services improved or declined from the previous year.
Accountability is based on the belief that the citizenry has a “right to know” about public resources raised during a fiscal period and the purposes for which the resources were used. In a democratic society, public officials have an obligation to be accountable to the public.
GASB’s focus is on external users. GASB believes external users
(1) Need to compare actual financial results with the legally adopted budget;
(2) Assess financial condition and results of financial operations;
(3) Assist in determining compliance with finance-related laws, rules, and regulations;
(4) Assist in evaluating efficiency and effectiveness.
Non-Governmental Not For Profits – FASB
Financial reports of not-for-profit organizations—voluntary health and welfare organizations, private colleges and universities, private health care institutions, religious organizations, etc. Emphasize decision usefulness over financial accountability needs. We will look at this subject more extensively in the semester.
FASB issues standards that focus on both internal and external financial reporting
FASB believes that financial reports of not-for-profit organizations should provide information (1) useful in making resource allocation decisions, (2) useful in assessing services and ability to provide services, (3) useful in assessing management stewardship and performance, and (4) about economic resources, obligations, net resources, and changes in them
Reporting required by the Federal Government, State and Local Governments, and Not-For-Profits
Financial reports can be read intelligently only by persons who understand the real meaning of the terms used in the reports, and who understand the standards that guide the presentation of financial information.
I. Financial Reporting of the Federal Government (Read generally)
U.S. Government-Wide Financial Reporting
The Department of the Treasury has prepared a prototype consolidated financial report for the U.S. government as a whole. The consolidated financial report includes a “plain language” Citizen’s Guide, a management’s discussion and analysis (MD&A), several financial statements, and supplemental information that report both on the government’s budget and proprietary financial activities, as well as reconciliation of the two.
Readers may be shocked to learn that despite the enormous dollar amounts involved, the U.S. Comptroller General has never been able to issue an audit opinion on the federal government’s consolidated financial statements. In general, serious financial management and data deficiencies are cited for the Comptroller General’s continuing disclaimer of opinion.
Federal Department and Agency Financial Reporting
The federal Office of Management and Budget requires major federal departments and agencies to prepare a performance and accountability report (PAR) that includes an annual performance report, annual financial statements, and a variety of management reports on internal control and other accountability issues.
The PAR has four sections containing:
An MD&A, which serves as a brief overview of the entire PAR and clearly describes the department or agency’s mission and organizational structure; its performance goals, objectives, and results; analysis of its financial statements; and analysis of information about internal controls and legal compliance.
Performance information. The annual performance report (APR) provides information about the agency’s performance and progress in achieving its performance goals.
Basic financial statements. These include a balance sheet, statement of net cost (essentially an operating statement format that is presented with expenses reported before revenues; that is, program costs minus earned revenues results in net cost), statement of changes in net position (similar to changes in owners’ equity in business accounting), statement of budgetary resources, statement of custodial activity, and statement of social insurance.
Other accompanying information, such as perspectives on the tax burden, size of the tax gap, challenges facing management, and revenue forgone.
Federal government financial reporting places a strong emphasis on management’s performance, in addition to the reporting of financial information.
II. State and Local Governments – GASB
The GASB is concerned with establishing standards for financial reporting to external users (citizens) —those who lack the authority to prescribe the information they want and who must rely on the information management communicates to them. The Board does not intend to set standards for reporting to managers and administrators or others deemed to have the ability to enforce their demands for information. One of GASB’s reporting objectives is the concept of interperiod equity whereby current-year revenues are sufficient to pay for services provided that year, so that future taxpayers will not be required to assume the burden for services previously provided.
GASB reports do not focus on assisting users to focus on the adequacy of systems and controls.
Management’s Discussion and Analysis which communicates in narrative, easily readable form the purpose of the basic financial statements and the government’s current financial position and results of financial activities compared with those of the prior year.
Government-wide financial statements
These statements provide an aggregated overview of a government’s net position and changes in net position. Net position is similar to the FASB term net assets (Assets minus liabilities equals equity).
The focus is on operational accountability. Operational accountability focuses on the efficient and effective use of resources by the government in the long term. It is considered the responsibility of governments to report the extent to which they have met their operating objectives efficiently and effectively, using all resources available for that purpose, and whether they can continue to meet their objectives for the foreseeable future
Basis of Accounting. Operational accountability is captured using accrual accounting.
Both short and long term assets and liabilities are reported
Depreciation is reported
Revenue is reported when earned and can be measured
Expenses are reported when incurred and can be measured.
Individual Funds financial statements
These statements provide more detailed financial information about the government. The fund categories closely align to general purpose government wide statements with a variety of accounting bases and financial statements depending upon the type of fund.
Required Supplementary Information (RSI) – All matters required by not included in the Management’s Discussion and Analysis.
Helpful But Not Required – Comprehensive Annual Financial Report
Serious users of government financial information need more detail than is found in the MD&A, basic financial statements, and Required Supplementary Information. For state and local governments, much of that detail is found in the government’s comprehensive annual financial report (CAFR). Although governments are not required to prepare a CAFR, most do so as a matter of public record and to provide additional financial details.
A CAFR prepared in conformity with these standards should contain the following sections.
Introductory Section The introductory section typically includes items such as a title page and contents page, a letter of transmittal, a description of the government, and other items deemed appropriate by management. The letter or narrative material should cite legal and policy requirements for the report.
Financial Section The financial section of a comprehensive annual financial report should include (1) an auditor’s report, (2) management’s discussion and analysis (MD&A), (3) basic financial statements, (4) required supplementary information, and (5) other supplementary information, such as combining statements and individual fund statements and schedules.
Laws regarding the audit of governments vary from state to state
The financial section should contain sufficient information to disclose fully and present fairly the financial position and results of financial operations during the fiscal year.
Considerations: Laws of higher jurisdictions, actions of the legislative branch of the government itself, and agreements with creditors and others impose constraints over governments’ financial activities and create unique financial accountability requirements.
Statistical Section The statistical section typically presents tables and charts showing demographic and economic data, financial trends, fiscal capacity, and operating information of the government in the detail needed by readers who are more than casually interested in the activities of the government.
By definition, the comprehensive annual financial report (CAFR) is more inclusive than the general purpose external financial information described in GASB standards. The CAFR presents three types of information: (1) introductory material from the entity’s management, such as transmittal letters, organizational charts, and awards; (2) financial statements (including the financial information required by GASB); and (3) statistical information, such as demographic information about the entity and summaries of tax rates and property assessed values over time. By contrast, GASB standards require (1) management discussion & analysis (MD&A), (2) government-wide financial statements, (3) fund financial statements, (4) notes to those statements, and (5) other required supplementary information (RSI)
Service Efforts and Accomplishments (SEA) reports.
Some governments publish highly condensed popular reports. These reports usually contain selected data from the audited financial statements, statistical data, graphic displays, and narrative explanations, but the reports themselves are not audited.
In addition, many state and local governments have begun to identify and report nonfinancial performance measures.
For nearly 20 years, the GASB has encouraged state and local governments to experiment with reporting service efforts and accomplishments (SEA) measures to provide more complete information about a government’s performance than can be provided by basic financial statements, budgetary comparison statements, and schedules.
Indicators of service efforts include inputs of nonmonetary resources as well as inputs of dollars. Indicators of service accomplishments include both outputs and outcomes; outputs are quantitative measures of work done, such as the number of juvenile cases handled, and outcomes are the impacts of outputs on program objectives, such as a reduction in the high school dropout rate or incidence of juvenile crime.
III. Financial Reporting of Not-for-Profit Organizations (NFPs)
A difference in the financial reporting objectives for governmental entities and not-for-profit entities is that governmental entities report on compliance with laws, regulations, and rules that impact financial reports.
Most NFPs, however, are nongovernmental in nature and, therefore, follow FASB accounting and financial reporting standards. The primary purpose of NFP financial statements is to provide decision-useful financial information to resource providers, principally donors, members, and creditors, among others.
Resource providers have in common the need to assess (1) the services provided by an NFP and the ability of the NFP to continue to provide those services, and (2) management’s performance and stewardship of resources
To meet these reporting needs, FASB standards require NFPs to prepare a set of organization-wide financial statements that include a statement of financial position (balance sheet), a statement of activities (income statement), and a statement of cash flows. There is no requirement for Management Discussion and Analysis.
In addition, NFPs classified as voluntary health and welfare organizations (health-related and community services organizations such as the YMCA, American Heart Association, and United Way) are required to provide a statement of functional expenses. The latter statement classifies expenses into program and supporting services categories, in addition to natural classifications such as personnel, supplies, and travel.
Chapter 13 provides examples of all these statements.
Many NFPs depend heavily on donor contributions to finance their operations. Donors often impose restrictions on the use of contributions, such as specifying that their contribution be used for a particular purpose or in a particular time period. Donor-imposed restrictions may be temporary or, in the case of certain endowments, permanent. Permanent endowments require the NFP to maintain the principal amount of the contribution in perpetuity but permit the use of earnings on invested principal, either without restriction or for a particular restricted purpose.
FASB standards recognize the essential need for management to demonstrate accountability for donor-restricted resources. Specifically, the standards require that an NFP’s statement of financial position report net assets (the excess of total assets over total liabilities) in three categories:
The statement of activities reports increases and decreases in each of the three categories of net assets.
In addition, it is important that an NFP’s statement of activities report expenses incurred for direct support of programs separately from supporting expenses (more formally titled, management and general expenses) and fund-raising costs. Reporting expenses in this way is an important aspect of accountability since it allows donors, oversight bodies, and others to calculate what percentage of total expenses is being incurred for program purposes, rather than for overhead and fund-raising.
Would you want to contribute to an NFP that spent more for administrative support and fund-raising than for its core mission?
The GASB Integrated Accounting and Financial Reporting Model
Overview of Semester
GASB Principles, Standards, and Financial Reporting
Part 1 of the text (Chapters 2–9) focuses on state and local governments. The principles that underlie GASB accounting and reporting standards are presented in Chapter 2. Chapters 3 through 8 provide detailed illustrations of the effect of financial transactions on the funds and government-wide statements. Financial reporting for state and local governments is described in detail in Chapter 9.
We will work on a record keeping for a governmental entity during class which covers chapters 2 through 9. It is easier to absorb this material by experiential learning. To show competency, you will have a project on Chapters 2 through 6 and 9 to be handed in.
Chapter 13 provides detailed illustrations of the effect of financial transactions on the financial statements of not-for-profit organizations, much like Chapters 3 through 8 do for state and local governments.