In this video, we walk through 5 BAR practice questions on converting governmental funds to governmental activities. 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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Converting Governmental Funds to Governmental Activities
Governmental fund financial statements are prepared differently from the governmental activities reported in the government-wide financial statements. Governmental funds use the current financial resources measurement focus and modified accrual accounting, while governmental activities use the economic resources measurement focus and accrual accounting.
In simple terms, governmental funds mainly show resources available soon to pay current bills. Governmental activities show the broader financial picture, including long-term assets, long-term liabilities, depreciation, and accrued revenues and expenses.
The worksheet conversion adjusts the governmental fund statements so they can be reported as governmental activities in the government-wide financial statements.
Governmental Funds Use a Short-Term View
Governmental funds generally report current assets, current liabilities, revenues that are measurable and available, and expenditures when current resources are used.
Because of this, governmental funds do not report many long-term items. General capital assets are not reported as assets in the governmental funds, and long-term debt is generally not reported as a liability.
The worksheet bridges the gap between the short-term governmental fund view and the full accrual-basis government-wide view.
Capital Assets Are Reported as Assets
One of the most common worksheet adjustments involves capital assets.
When a governmental fund purchases a capital asset, the purchase is reported as a capital outlay expenditure. In the governmental activities column, the same purchase is reported as a capital asset instead of being treated as a current-period expense.
The government-wide statements also report depreciation expense over the asset’s useful life.
For example, if a city’s general fund purchases a fire truck, the governmental fund reports the purchase as an expenditure. In the governmental activities column, the worksheet removes the capital outlay expenditure, records the fire truck as a capital asset, and records depreciation expense for the period.
Principal Payments Reduce Long-Term Debt
Debt service payments also require conversion.
Governmental funds report debt service payments as expenditures. This can include both principal and interest.
In governmental activities, the principal portion of a debt payment is not an expense. It reduces the outstanding long-term debt liability.
For example, if a city makes a debt service payment and part of the payment is principal, the governmental fund may report that principal amount as an expenditure. In the governmental activities column, the worksheet removes the principal payment from expenditures and records it as a reduction of long-term debt.
The interest portion is treated separately because interest is generally an expense, although the timing may need to be adjusted under accrual accounting.
Interest Expense Is Reported When Incurred
Governmental funds generally report interest expenditures when interest is due and payable. Governmental activities report interest expense in the period the interest is incurred.
If interest has been incurred by year-end but will not be paid until the next fiscal year, the governmental fund may not report an expenditure. In the governmental activities column, the worksheet records interest expense and the related liability.
If several years of interest are paid at once, the governmental fund may report the full payment as an expenditure in the year paid. In the governmental activities column, only the amount related to the current period is reported as current-year interest expense.
The worksheet conversion makes the interest amount match accrual accounting rather than simply following the payment date or due date.
Some Deferred Revenues Are Recognized in Governmental Activities
Revenue recognition may also require a worksheet adjustment.
Governmental funds recognize revenue only when it is measurable and available. If revenue is measurable but not available soon enough, the governmental fund may report a deferred inflow of resources instead of revenue.
Governmental activities use accrual accounting. If the revenue meets the accrual-basis recognition requirements and was deferred in the governmental funds only because it was not available soon enough, the worksheet removes the deferred inflow and recognizes revenue.
For example, property taxes may be reported as a deferred inflow in the governmental fund statements if they are not expected to be collected within the availability period. If those taxes meet the accrual-basis recognition requirements for governmental activities, the worksheet conversion recognizes the revenue.
This does not mean all deferred inflows automatically become revenue in the governmental activities column. If an amount is deferred because it relates to a future period, it generally remains deferred.
Internal Service Funds Are Often Included with Governmental Activities
Internal service funds are proprietary funds, but they are often reported with governmental activities in the government-wide financial statements.
This usually happens when the internal service fund primarily serves governmental departments. Examples include fleet maintenance, information technology, printing, or similar support services.
If the internal service fund primarily supports governmental departments, its remaining assets and liabilities are generally included with governmental activities. The classification is based on the activities the fund primarily serves, not simply on the fact that the internal service fund is a proprietary fund.
The Main Point
Worksheet adjustments convert the governmental fund statements from the short-term fund view to the full government-wide view.
That difference explains the major worksheet adjustments. Capital outlay is converted into capital assets and depreciation. Principal payments are converted into reductions of long-term debt. Interest is adjusted to the period incurred. Revenue deferred only because it was unavailable under modified accrual may be recognized under accrual accounting. Internal service fund balances may be included with governmental activities when they primarily support governmental departments.
When governmental fund accounting and government-wide accounting treat an item differently, the worksheet is used to convert the fund-basis amount to the governmental activities amount.
