In this video, we walk through 5 BAR practice questions teaching about proprietary funds statement of cash flows. These questions are from BAR content area 3 on the AICPA CPA exam blueprints: State and Local Governments
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Proprietary Funds Statement of Cash Flows
Proprietary funds in state and local governments—such as enterprise funds (e.g., utilities, airports) and internal service funds—are designed to account for activities that operate much like businesses. One of the key financial reports they prepare is the statement of cash flows, which provides insight into how these funds generate and use cash. Under the Governmental Accounting Standards Board (GASB) standards, this statement has a specific format that differs from private-sector practice, and understanding its categories is essential.
The Four Required Categories
Unlike the private sector, which uses three sections (operating, investing, financing), GASB requires four:
- Operating activities – cash received and paid in the normal course of providing services.
Example: A water utility enterprise fund collects $6.2 million in customer billings and pays $4.7 million to suppliers and employees. The net $1.5 million is reported as operating cash flow. - Noncapital financing activities – inflows and outflows of cash not related to capital assets but intended to support operations.
Example: A city airport enterprise fund receives a $100,000 interfund transfer to subsidize operations. This is noncapital financing. - Capital and related financing activities – cash flows tied to acquiring, constructing, or repaying debt on capital assets.
Example: A city’s water utility issues $2.5 million in revenue bonds to build a treatment plant and pays $1.8 million for construction. The $700,000 net is capital and related financing. - Investing activities – cash used for and generated from investments.
Example: An enterprise fund buys $500,000 of Treasury securities, sells $200,000 of investments, and earns $40,000 in interest. The net of $(260,000) is an investing activity.
Why the Categories Matter
The distinction between categories is important because it shows how funds are sustained:
- Operating activities reveal whether day-to-day services are self-supporting. If a utility consistently generates positive operating cash flows, it signals financial sustainability.
- Noncapital financing activities highlight dependence on subsidies or grants. For instance, federal operating grants of $400,000 reported here indicate reliance on outside funding for ongoing operations.
- Capital and related financing activities demonstrate the cost of maintaining and expanding infrastructure. Bond issuances and capital construction costs fall into this category, showing how governments fund long-term assets.
- Investing activities reflect how surplus cash is managed and whether investment strategies support or strain liquidity.
Illustration Through Practice Questions
Several examples highlight how transactions are classified:
- Customer receipts and supplier payments: Always operating. In one case, $4.5 million was received from billings, and $3.2 million was paid out, leaving $1.3 million net operating cash.
- Federal operating grants or interfund transfers: Noncapital financing. For example, a grant of $200,000 and a transfer of $300,000 were both reported in this section.
- Bond proceeds and equipment purchases: Capital and related financing. When $1 million of revenue bonds were issued and $600,000 was spent on equipment, the net $400,000 was reported here.
- Interest on investments: Investing activity. The $50,000 received was classified accordingly.
By applying these rules, students and practitioners can correctly assign cash flows to their categories, avoiding common misclassifications.
Key Differences From Private-Sector Statements
One of the most notable features is GASB’s treatment of interest. In private business reporting under FASB, interest paid and received often appear under operating activities. In contrast, GASB requires interest on investments to be classified under investing activities and interest on debt tied to capital assets under capital and related financing activities. This makes governmental cash flow statements more precise in showing the source and purpose of funds.
Putting It All Together
A complete statement of cash flows for a proprietary fund will combine all categories to present the net change in cash for the year. For instance:
- Operating activities: $1,300,000
- Noncapital financing: $700,000
- Capital and related financing: $700,000
- Investing activities: $(260,000)
Net increase in cash: $2,440,000.
This total reconciles to the cash balances reported in the proprietary fund’s balance sheet.
Conclusion
Preparing the statement of cash flows for proprietary funds requires careful attention to GASB’s four categories. By recognizing which transactions belong in operating, noncapital financing, capital and related financing, and investing, financial statement preparers ensure transparency and accuracy. The examples of utilities, airports, and equipment purchases demonstrate how real-world events translate into classifications.
