BAR CPA Practice Questions: Required Governmental Funds

In this video, we walk through 5 BAR practice questions teaching about required governmental funds. These questions are from BAR content area 3 on the AICPA CPA exam blueprints: State and Local Governments

The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.

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Required Governmental Funds

When studying governmental accounting one of the key areas is the ability to identify and recall the basic concepts and principles associated with governmental fund financial statements. This includes knowing the required governmental funds, how they are used, and what financial statements they produce. It also requires recognizing the differences between revenues, expenditures, and other financing sources and uses.

The Purpose of Governmental Funds

Governmental funds focus on activities that are financed primarily through taxes, grants, and general revenues. They use the modified accrual basis of accounting and the current financial resources measurement focus. This means the emphasis is on short-term inflows and outflows of spendable resources rather than long-term economic impact. The five required governmental funds are:

• General Fund – the primary fund for ordinary operations.
• Special Revenue Fund – accounts for legally restricted revenues earmarked for specific purposes other than capital projects or debt service.
• Capital Projects Fund – used for acquisition or construction of major capital facilities.
• Debt Service Fund – set aside for the accumulation of resources and the payment of principal and interest on general long-term debt.
• Permanent Fund – where the principal must be maintained intact in perpetuity, with only earnings used to support government programs.

Examples of Fund Applications

The review questions illustrate how each fund operates in practice.

• Debt Service Fund example: A city collects property taxes restricted for repaying its bonds and uses them to make principal and interest payments. Both the revenues and the payments are recorded in the debt service fund.
• Capital Projects Fund example: Proceeds from a state grant to build a new library, along with the construction expenditures, are reported in the capital projects fund.
• Special Revenue Fund example: Gasoline tax revenues restricted by law for road maintenance are recorded in a special revenue fund because they are legally committed to an ongoing program.
• General Fund example: Property taxes for general operations belong in the general fund rather than in a restricted or project-based fund.

These distinctions demonstrate that governmental funds are designed to emphasize accountability and legal compliance, ensuring that resources are used in the manner intended.

Revenues, Expenditures, and Other Financing Sources and Uses

Another principle is how to classify different inflows and outflows.

• Revenues are inflows from taxes, grants, or other legally available resources. For example, $600,000 in restricted property tax revenues is reported as debt service fund revenues even if not all of it is spent.
• Expenditures are outflows for goods, services, or debt service payments. Paying $400,000 of bond principal and interest is an expenditure in the debt service fund.
• Other Financing Sources and Uses capture transfers between funds and debt issuances. For instance, when the general fund transfers $300,000 to the debt service fund, it records the amount as an other financing use, not as an expenditure. The debt service fund records the same transfer as an other financing source.

This separation ensures that internal transfers are not mistaken for true revenues or expenditures.

Financial Statements of Governmental Funds

Each major governmental fund, and the total of all nonmajor funds, is reported in two financial statements:

1. Balance Sheet – shows assets, liabilities, and fund balances, which are classified as nonspendable, restricted, committed, assigned, or unassigned.
2. Statement of Revenues, Expenditures, and Changes in Fund Balances – presents inflows, outflows, and the change in fund balance during the period.

For example, in a debt service fund scenario:

• Revenues: $600,000 in restricted property taxes
• Expenditures: $400,000 in principal and interest
• Increase in restricted fund balance: $200,000 retained for future debt service

This presentation highlights both the amounts spent and the resources still available for legally mandated purposes.

Pillar Takeaways

The scenarios and explanations reinforce several key pillars:

• Debt Service Fund – tracks accumulation and payment of general long-term debt.
• Capital Projects Fund – records resources used to build or acquire major assets like schools, libraries, or bridges.
• Special Revenue Fund – captures legally restricted revenues for specific ongoing purposes.
• Other Financing Uses – represent interfund transfers, not expenditures.
• Fund Distinction – the general fund handles ordinary operations, while the other funds serve legally restricted or specialized purposes.

Why These Concepts Matter

In practice, misclassifying transactions can lead to incorrect reporting. Recording a restricted tax for debt repayment in the general fund would obscure accountability for debt service. Treating a transfer as an expenditure would inflate reported spending. The structure of governmental funds prevents these errors and provides clarity about how governments raise, spend, and reserve resources.