Introduction
Overview of Fund Accounting for State and Local Governments
In this article, we’ll cover how to calculate the fund balances for state and local governments and prepare journal entries. Fund accounting is a system utilized by state and local governments to ensure that resources are appropriately tracked and allocated according to their designated purposes. The key objective of fund accounting is to promote accountability by distinguishing various financial activities and ensuring compliance with legal and regulatory requirements. Governments often manage multiple funds, each with specific restrictions, allowing them to separate resources and their uses based on their intended purpose.
This approach is crucial for providing transparency to stakeholders, including government officials, auditors, and the public. Fund accounting enables governments to demonstrate that they are using public resources responsibly and in line with legal or donor-imposed restrictions.
Purpose and Importance of Fund Balances
Fund balances represent the difference between a government’s assets and liabilities at a specific point in time. They are crucial for indicating the availability of resources for future use and highlighting any limitations placed on how those resources can be used. Different categories of fund balances, such as nonspendable, restricted, committed, assigned, and unassigned, provide a clear picture of both available and restricted resources.
Fund balances serve a vital role in helping governments assess their financial health and make informed decisions about future spending, saving, and budgeting. They also provide transparency to taxpayers, grantors, and oversight bodies, ensuring that funds are used appropriately and in alignment with designated purposes.
Differences Between Fund Balances and Net Positions in Governmental Accounting
Fund balances and net positions are both measures of a government’s financial position but differ in scope and reporting.
- Fund Balances are specific to governmental funds, which use a modified accrual basis of accounting. They focus on current financial resources available for spending and are categorized into different classifications (e.g., restricted, committed, unassigned).
- Net Position is used in government-wide financial statements prepared on a full accrual basis, capturing a broader view of a government’s assets and liabilities. Net position reflects the overall financial health of the government, combining all funds and activities, including long-term assets and obligations.
While fund balances provide a detailed view of available resources within individual funds, net position reflects the government’s financial status as a whole, including both short-term and long-term assets and liabilities.
Brief Overview of the Governmental Accounting Standards Board (GASB) Statement No. 54
The Governmental Accounting Standards Board (GASB) issued Statement No. 54 to enhance the clarity and transparency of fund balance reporting for state and local governments. Effective for financial statements from periods beginning after June 15, 2010, GASB 54 established a structured framework for classifying fund balances based on the level of restriction on the use of funds.
GASB 54 introduced five classifications of fund balances:
- Nonspendable: Funds not in a spendable form, such as inventory or prepaid expenses.
- Restricted: Funds subject to external legal restrictions or constraints, such as grants or external laws.
- Committed: Funds that can only be used for a specific purpose, as determined by formal government action (e.g., legislation or a city council resolution).
- Assigned: Funds that are intended for specific purposes but without formal government commitment.
- Unassigned: The remaining funds not classified into other categories, usually found in the General Fund.
The objective of GASB 54 was to improve the understanding of how governments categorize, manage, and report their available resources. This standardized approach to fund balance reporting promotes transparency and consistency across governmental financial statements, ensuring that stakeholders can accurately assess a government’s financial position.
Types of Fund Balances Defined
Nonspendable Fund Balances
Definition and Characteristics
Nonspendable fund balances represent the portion of resources that cannot be spent because they are either not in spendable form or are legally or contractually required to remain intact. This classification ensures that certain assets are preserved and not utilized for day-to-day operations or immediate financial needs. Nonspendable fund balances are typically composed of long-term assets, prepaid expenses, or other financial resources that are not readily convertible into cash.
Key characteristics of nonspendable fund balances include:
- Inconvertibility to Cash: These funds are tied up in assets that cannot easily be liquidated or used to finance current operations.
- Obligations to Retain: Certain resources must remain intact either due to legal requirements or because they are part of a permanent endowment or similar arrangement.
- Preservation of Resources: These fund balances emphasize maintaining resources for long-term use or contractual obligations, rather than allowing for immediate expenditure.
Examples: Inventory, Prepaid Expenses, Long-term Loans
Several types of resources commonly fall into the nonspendable fund balance category:
- Inventory: Items such as supplies or materials that are held by the government for future use. Inventory is not readily available for immediate spending because it represents goods to be consumed over time.
- Prepaid Expenses: Payments made in advance for goods or services, such as insurance or rental agreements, that cannot be reclaimed or converted into cash until the services are rendered or the time period has passed.
- Long-term Loans: Loans issued by the government with long repayment periods are classified as nonspendable because the funds are not available for immediate expenditure. These assets are tied up in loan agreements and cannot be used for current financial needs.
When and How These Funds Are Classified as Nonspendable
The classification of nonspendable fund balances occurs during the preparation of the financial statements, typically when assets are reviewed and categorized based on their liquidity and spendability. For resources to be classified as nonspendable, they must meet the following criteria:
- Non-Liquid Nature: The resource is not in cash form and cannot easily be converted into cash (e.g., physical inventory or prepaid items).
- Legal or Contractual Requirements: The resource is subject to a legal or contractual obligation that requires it to remain intact, such as endowments or loans that must be retained until their maturity.
The classification process involves examining the balance sheet for items that fit these characteristics. Once identified, the nonspendable resources are listed separately from other fund balances, ensuring transparency in how these resources are earmarked and preserved for future use.
Nonspendable fund balances play a crucial role in governmental accounting by protecting resources that are not immediately available, thus ensuring that governments remain transparent in their reporting and accountable for the long-term management of their assets.
Restricted Fund Balances
Definition and Characteristics
Restricted fund balances represent resources that are constrained by external parties or legal provisions, meaning they can only be used for specific purposes as defined by outside authorities, such as creditors, grantors, or laws. These restrictions are binding and legally enforceable, requiring that the funds be used in accordance with the specified purpose.
Key characteristics of restricted fund balances include:
- External Imposition: The restrictions on these funds are imposed by sources external to the government, such as law, creditors, or grant agreements.
- Legally Binding: These constraints are legally enforceable, meaning the government is obligated to adhere to the stipulated use of the funds.
- Purpose-Specific: The funds are earmarked for a designated purpose, such as funding a particular project or program, and cannot be diverted to other uses without violating the restriction.
Legal Constraints: External Restrictions from Laws, Creditors, or Donors
Restricted fund balances arise when legal or contractual obligations dictate how certain resources must be used. These restrictions can come from a variety of sources:
- Laws or Regulations: Governmental entities are often subject to legal mandates that restrict the use of certain funds. For instance, revenue from a specific tax may be legally required to fund education or transportation projects.
- Creditors: In cases where a government entity has borrowed funds, the creditors may impose restrictions on how the borrowed money or future revenues must be utilized to ensure debt service and repayment.
- Donors or Grantors: Contributions from external entities, such as private donors or federal and state grants, often come with conditions that restrict the funds to particular programs or initiatives. For example, a donor may give funds with the stipulation that they be used only for building infrastructure.
These restrictions are external to the government and must be clearly adhered to in financial reporting to ensure compliance with the legal or contractual requirements.
Examples: Grant Funds Restricted for Specific Programs
Several common examples of restricted fund balances include:
- Grant Funds for Specific Programs: Government entities often receive grants from higher-level governments or private organizations with the condition that the funds be used only for designated programs. For example, a federal grant may be awarded to a state government to improve public transportation, and the grant funds must be restricted for this specific use.
- Debt Service Funds: When a government entity issues bonds to finance large projects, the funds set aside for repaying the debt are typically restricted. Creditors impose these restrictions to ensure that the funds are used for their intended purpose—repaying the principal and interest on the debt.
- Special Revenue Funds: In many cases, revenue generated from a specific source (such as a hotel tax or gasoline tax) is legally required to fund particular activities, such as tourism development or road maintenance. The revenue in these funds is considered restricted and must be used exclusively for its designated purpose.
Restricted fund balances ensure that government resources are used in a manner that complies with external mandates, offering accountability to creditors, grantors, and the public. Proper classification and reporting of these funds help maintain transparency and adherence to legal obligations.
Committed Fund Balances
Definition and Characteristics
Committed fund balances are resources that have been set aside for specific purposes by formal action of the government’s highest decision-making authority, such as a city council or state legislature. Unlike restricted fund balances, which are constrained by external parties, committed fund balances result from internal decisions that the government itself imposes. Once committed, these funds can only be redirected to other uses through another formal action by the same authority.
Key characteristics of committed fund balances include:
- Formal Government Action: The government must take formal action, such as passing an ordinance or resolution, to commit funds for a specific purpose.
- Self-imposed Constraint: These funds are restricted by the government’s own decision rather than external mandates, giving the government more control over their allocation.
- Alteration Requires Formal Action: Releasing or altering the commitment of these funds requires another formal action by the same governing body.
Role of Formal Government Actions (e.g., Ordinances or Resolutions) in Restricting These Funds
The process of committing funds begins with a formal decision by the government’s highest level of authority, such as a city council or state legislature. This typically occurs during the budgeting process or when setting aside funds for a large project or long-term goal. The government enacts a law, ordinance, or resolution that specifies the purpose for which the funds are to be used.
Once funds are committed through this formal action, they cannot be used for any other purpose without another action by the same governing body. This process ensures that the government has a high level of control and flexibility over its resources while maintaining accountability and transparency.
Examples of formal government actions that result in committed fund balances include:
- Passing an ordinance to allocate funds for a specific project, such as a new municipal building or infrastructure development.
- Adopting a resolution to set aside funds for long-term liabilities, such as pension obligations.
This legal framework ensures that governments can set aside funds for critical needs while retaining the ability to adapt to changing priorities or financial conditions through further action.
Examples: Capital Improvement Funds
Committed fund balances are often associated with major projects or specific government priorities. Common examples include:
- Capital Improvement Funds: Many governments commit funds for large capital projects, such as constructing new public buildings, roads, or parks. Through formal resolutions, the government can designate a portion of its resources to these projects, ensuring that the funds are preserved for this purpose.
- Emergency or Contingency Funds: Governments may also commit funds to be used in emergency situations, such as natural disasters or economic downturns. By committing these resources ahead of time, the government ensures that it has a financial cushion to address unexpected events.
- Debt Service Reserves: Some governments set aside committed funds specifically to make future debt payments. While restricted fund balances might be imposed by external creditors, committed funds for debt service reflect the government’s proactive planning to ensure that future obligations are met.
Committed fund balances provide a way for governments to exercise internal control over their resources while ensuring that critical projects or priorities are funded. This flexibility, combined with the requirement for formal government action, gives governments a structured method to allocate resources to long-term goals while maintaining accountability to stakeholders.
Assigned Fund Balances
Definition and Characteristics
Assigned fund balances represent amounts that the government intends to use for a specific purpose but have not been formally committed through legislative action. These funds are earmarked for a particular use by a government entity, such as the governing body or its designated officials, but they lack the legal or formal constraint that applies to restricted or committed fund balances. The intention to use the funds for a particular purpose can be communicated through less formal processes, such as budgeting, rather than a formal vote or resolution.
Key characteristics of assigned fund balances include:
- Internal Designation: Funds are internally designated for a specific purpose but do not require formal government action, such as a resolution or ordinance.
- Flexible Use: Assigned fund balances can be adjusted or reallocated more easily than committed or restricted funds, providing flexibility in resource management.
- Typically Found Outside the General Fund: In governmental accounting, assigned fund balances are most commonly found in funds other than the General Fund, though portions of the General Fund can also be assigned for specific purposes.
Assignment by Governments for a Specific Purpose Without Formal Commitment
Governments often assign funds for specific purposes as part of the budgetary process or other internal planning activities. Unlike committed fund balances, which require formal action by the government’s highest authority, assigned fund balances are created through more informal means. This assignment can be done by government officials, financial managers, or other delegated authorities, provided there is an intention to use the funds for a particular purpose.
For example, during the budget planning process, a government might decide to set aside funds for the purchase of new equipment or the maintenance of public facilities. The decision to assign funds does not need to go through a formal legislative process but is instead reflected in budget documents or internal memos. The assigned funds are then reported as part of the financial statements, indicating that the government has an internal plan to use them for a specific purpose.
How Assignments Differ from Restrictions or Commitments
Assigned fund balances differ from restricted and committed fund balances in several important ways:
- Flexibility of Use: Unlike restricted fund balances, which are constrained by external mandates (such as laws, donors, or creditors), and committed fund balances, which are set aside by formal government action, assigned fund balances can be more easily reallocated or adjusted. Since they are not legally or formally restricted, the government retains more flexibility to change their intended use as circumstances evolve.
- Lack of Formal Action: Committed fund balances require a formal action, such as a resolution or ordinance, to establish or alter. In contrast, assigned fund balances can be set aside without the need for a formal vote or binding resolution. This means that a department head or budget officer, for example, can assign funds based on operational needs or upcoming projects.
- Application to the General Fund: In the General Fund, only the portion that is designated for a specific use can be assigned, with the remainder typically classified as unassigned. However, in other governmental funds, the balance may be entirely assigned if no formal commitment or external restriction is in place.
Examples of assigned fund balances might include funds set aside for purchasing new equipment, road repairs, or upcoming special events that do not require formal legislative action.
Assigned fund balances serve as a useful tool for governments to plan and allocate resources for future needs while maintaining the flexibility to adapt to changing priorities. The ability to assign funds without the constraints of formal action provides governments with a practical method for managing resources in alignment with their operational goals.
Unassigned Fund Balances
Definition and Characteristics
Unassigned fund balances represent the portion of a government’s financial resources that is available for any purpose and is not subject to external or internal constraints. These funds are essentially the residual amount after all other fund balance categories—such as nonspendable, restricted, committed, and assigned—have been identified. The unassigned balance provides the most flexibility for governments, as it can be used for any legal purpose without specific restrictions or commitments.
Key characteristics of unassigned fund balances include:
- Complete Flexibility: These funds are free from any legal, external, or internal constraints and can be used to address unforeseen expenses, emergencies, or other needs as they arise.
- Residue of Other Classifications: Unassigned fund balances are calculated after all other types of fund balances (e.g., restricted, committed) have been allocated.
- General Fund Focus: This balance category is typically exclusive to the General Fund, as the other funds (e.g., special revenue funds, capital projects funds) often have specific purposes and restrictions that prevent an unassigned balance.
Residual Classification for the General Fund
The unassigned fund balance is primarily associated with the General Fund, which serves as the primary operating fund for most governments. The General Fund handles activities that are not accounted for in other specialized funds, making it the most flexible and unrestricted source of funding for government operations.
Within the General Fund, the unassigned balance acts as a financial buffer that the government can use for a variety of purposes, including:
- Addressing Budget Shortfalls: The unassigned balance can be used to cover unexpected deficits or revenue shortfalls during the fiscal year.
- Funding Emergencies or Contingencies: Governments can use unassigned funds to respond to emergencies, such as natural disasters or economic downturns, without needing to reallocate resources from other designated funds.
- Covering Unforeseen Expenses: These funds provide flexibility for handling unforeseen operational costs that were not anticipated during the budgeting process.
The unassigned fund balance is often a key indicator of the government’s financial health and stability, as it reflects the amount of resources available for general use or contingency planning.
Conditions Under Which Unassigned Funds Appear in Other Funds
While the unassigned fund balance is most commonly associated with the General Fund, there are certain conditions under which an unassigned fund balance might appear in other governmental funds. These conditions occur primarily when another fund has a negative balance or deficit. In such cases, the negative balance is classified as unassigned because no other resources are available to cover the shortfall.
Situations in which unassigned balances appear in other funds include:
- Negative Fund Balances in Other Funds: If a governmental fund other than the General Fund (such as a special revenue or capital projects fund) ends the fiscal year with a deficit, that deficit is recorded as an unassigned fund balance. This situation reflects that there are no remaining resources within the fund to cover the shortfall, and the unassigned category is used to signal the deficit.
- Liquidation of a Fund: If a special revenue fund or capital projects fund is closed out, and any remaining resources have been reallocated, the residual balance (if any) would be classified as unassigned if no legal restrictions or formal commitments exist.
These instances are exceptions to the general rule that unassigned balances are exclusive to the General Fund, and they typically occur when a fund has exhausted all other resources or obligations.
Unassigned fund balances provide governments with essential financial flexibility, allowing them to respond to changing circumstances and address unforeseen needs. In most cases, the unassigned balance serves as a financial safety net, ensuring that governments have adequate resources for emergencies and operational stability.
Steps to Calculate Fund Balances
Overview of the Calculation Process
Calculating fund balances for state and local governments involves categorizing financial resources into the appropriate fund balance classifications: nonspendable, restricted, committed, assigned, and unassigned. Each classification reflects varying degrees of legal or internal constraints on how the resources can be used. The process involves reviewing the government’s assets and liabilities, identifying legal or formal restrictions, and determining how much of the available resources are unencumbered and available for general use.
The goal is to ensure that financial reporting accurately reflects the availability of resources, their designated uses, and any limitations that apply. Below are the key steps involved in calculating the fund balances.
1. Identifying Nonspendable Resources
The first step in calculating fund balances is to identify nonspendable resources. These are assets that cannot be converted to cash or are legally required to remain intact. Common examples include inventory, prepaid expenses, and long-term receivables. These resources are not available for general spending because they are tied up in non-liquid forms or are subject to legal or contractual obligations.
Review of Assets That Are Not in Spendable Form (e.g., Inventory, Prepaid Expenses)
To classify nonspendable fund balances, governments must review their balance sheets for assets that cannot be immediately spent. This involves identifying:
- Inventory: Materials or supplies that the government holds for future use, which cannot be liquidated for cash.
- Prepaid Expenses: Expenses paid in advance for goods or services that will be received in the future, such as insurance or rent.
- Long-term Receivables: Loans or other receivables that will not be collected in the short term and therefore are not available for immediate spending.
Once these nonspendable resources are identified, they are deducted from the total fund balance to ensure the remaining balance reflects only spendable resources.
2. Determining Restricted Resources
The next step is to identify restricted resources, which are subject to external legal or contractual restrictions that limit their use. These restrictions can come from creditors, grantors, legislation, or other external sources. Restricted fund balances must be used for specific purposes, such as debt service, capital projects, or federal and state grant programs.
Review of Legal and External Restrictions on Resources
Governments must review their financial statements and legal agreements to determine if any resources are restricted by:
- Grant Agreements: Funds received through grants that are legally required to be used for specific programs or projects.
- Debt Covenants: Bond or loan agreements that require the government to set aside funds for future debt payments.
- Legislative Mandates: Laws or regulations that designate certain funds for particular purposes, such as education or transportation infrastructure.
These restricted amounts are categorized separately from other fund balances to ensure compliance with external mandates.
3. Committed Resources
Committed resources are those that have been set aside for a specific purpose through formal action by the government’s highest decision-making authority, such as a city council or legislative body. These funds are earmarked for specific uses and cannot be repurposed without additional formal action to remove the commitment.
Analyze Formal Actions (Legislation, Board Resolutions) That Have Restricted Funds
To determine committed fund balances, governments must analyze:
- Resolutions or Ordinances: Formal actions passed by governing bodies that commit resources to specific projects or initiatives, such as capital improvements or emergency reserves.
- Budgetary Decisions: Formal budget allocations that designate funds for long-term projects or financial contingencies.
Committed resources require a higher level of formal action than assigned resources and cannot be easily reallocated without similar formal procedures.
4. Assigned Resources
Assigned resources are funds intended for specific purposes, but without the formal commitment required for committed resources. These assignments are often made by management or designated officials as part of the budgeting process. Although assigned funds are not legally restricted, they represent planned uses of resources.
Analyze Budgetary and Other Internal Designations Made by Management or the Governing Body
To identify assigned resources, governments must review:
- Budgetary Allocations: Funds set aside during the budget planning process for upcoming projects, equipment purchases, or other anticipated needs.
- Internal Policies: Management decisions or internal policies that designate resources for particular purposes, such as future maintenance projects or operating reserves.
Assigned resources provide flexibility, allowing governments to adjust or reassign these funds as needed without formal legislative action.
5. Unassigned Resources
The final step is to calculate the unassigned fund balance, which represents the residual resources available for general use. Unassigned funds are not restricted, committed, or assigned to any specific purpose, making them the most flexible portion of the government’s financial resources. The unassigned balance is primarily found in the General Fund, where it acts as a cushion for unforeseen expenses or budget shortfalls.
Calculate Remaining Resources Not Categorized Into Other Classifications
To determine the unassigned fund balance:
- Subtract Nonspendable, Restricted, Committed, and Assigned Amounts from the total fund balance.
- Allocate Remaining Resources to the unassigned fund balance, representing the funds available for any general government purpose.
In other funds, unassigned balances only appear if the fund has a deficit, indicating that there are no remaining spendable resources to cover liabilities. In the General Fund, the unassigned balance is a key indicator of financial flexibility and stability.
By following these steps, governments can accurately classify their fund balances, providing transparency and accountability in how resources are allocated and available for future spending. Proper categorization ensures compliance with legal and internal requirements while offering insight into the government’s financial health.
Example Calculation and Fund Balance Classification
Provide a Scenario of a Government Entity’s Balance Sheet
Let’s consider a scenario involving a government entity that needs to classify its fund balances based on its year-end balance sheet. The entity’s financial information includes assets such as cash, investments, inventory, grants received for specific projects, and funds allocated for future capital improvements.
Here’s a simplified version of the entity’s balance sheet:
Government Entity’s Year-End Balance Sheet
| Assets | Amount |
|---|---|
| Cash and Cash Equivalents | $500,000 |
| Investments | $300,000 |
| Inventory | $100,000 |
| Prepaid Insurance | $50,000 |
| Grant Funds for School Construction | $200,000 |
| Capital Improvement Fund (Committed) | $250,000 |
| Operating Budget Reserve (Assigned) | $150,000 |
| Total Assets | $1,550,000 |
Breakdown of Assets and Fund Balances
Based on the information in the balance sheet, we will categorize the assets into nonspendable, restricted, committed, assigned, and unassigned fund balances. The step-by-step process is as follows:
1. Nonspendable Fund Balances
Nonspendable fund balances include assets that are not in spendable form or are legally or contractually required to remain intact. In this case, the entity has two types of nonspendable assets:
- Inventory: $100,000
- Prepaid Insurance: $50,000
These amounts will be classified as nonspendable because they are not available for immediate spending.
Total Nonspendable Fund Balance: $150,000
2. Restricted Fund Balances
Restricted fund balances consist of resources that are subject to external constraints, such as legal requirements or grantor conditions. In this example, the government has grant funds specifically allocated for school construction:
- Grant Funds for School Construction: $200,000
These funds are restricted by the grant agreement and can only be used for the designated construction project.
Total Restricted Fund Balance: $200,000
3. Committed Fund Balances
Committed fund balances are resources that have been set aside for specific purposes through formal action by the government’s highest decision-making authority. In this case, the entity has committed funds for capital improvements:
- Capital Improvement Fund: $250,000
These funds have been earmarked by a resolution passed by the city council for future capital projects, such as road construction or building renovations.
Total Committed Fund Balance: $250,000
4. Assigned Fund Balances
Assigned fund balances include resources that are intended for a specific purpose but have not been formally committed through government action. In this example, the government has assigned funds as part of its operating budget reserve for future use:
- Operating Budget Reserve: $150,000
These funds are designated for potential budget shortfalls or unforeseen operational expenses, but there is no formal commitment, making them assigned rather than committed.
Total Assigned Fund Balance: $150,000
5. Unassigned Fund Balances
The unassigned fund balance represents the residual resources that are available for any purpose. After allocating resources to nonspendable, restricted, committed, and assigned fund balances, the remaining balance is unassigned. To calculate this, subtract the total of all other fund balances from the total assets.
Unassigned Fund Balance Calculation:
- Total Assets: $1,550,000
- Nonspendable Fund Balance: $150,000
- Restricted Fund Balance: $200,000
- Committed Fund Balance: $250,000
- Assigned Fund Balance: $150,000
Unassigned Fund Balance = $1,550,000 – ($150,000 + $200,000 + $250,000 + $150,000)
Unassigned Fund Balance = $800,000
Total Unassigned Fund Balance: $800,000
Summary of Fund Balance Classification
After classifying the government’s resources, the fund balances are as follows:
| Fund Balance Category | Amount |
|---|---|
| Nonspendable | $150,000 |
| Restricted | $200,000 |
| Committed | $250,000 |
| Assigned | $150,000 |
| Unassigned | $800,000 |
| Total Fund Balance | $1,550,000 |
This example demonstrates how a government entity categorizes its assets into nonspendable, restricted, committed, assigned, and unassigned fund balances, providing a clear and transparent representation of how its resources are available and allocated.
Journal Entries for Fund Balances
1. Journal Entry for Nonspendable Fund Balances
Explanation
Nonspendable fund balances include resources that are not in spendable form, such as inventory or prepaid expenses. These assets cannot be used to meet the current financial obligations of the government, as they are either locked in long-term form or are committed to be used over time. Journal entries are typically made to adjust the balance of these nonspendable resources as they are consumed or recognized.
Sample Journal Entries
Inventory Adjustments
When the government purchases inventory, the entry is recorded to recognize the asset. As inventory is consumed, an adjustment is made to reflect the usage.
- Purchase of Inventory:
Debit: Inventory $100,000
Credit: Cash $100,000
- Consumption of Inventory:
Debit: Expenditure – Supplies $20,000
Credit: Inventory $20,000
Prepaid Expenses
When the government makes a prepaid payment, such as for insurance, the balance is recorded as an asset. As the prepaid expense is recognized over time, the entry is adjusted accordingly.
- Payment of Prepaid Insurance:
Debit: Prepaid Insurance $50,000
Credit: Cash $50,000
- Recognition of Insurance Expense:
Debit: Expenditure – Insurance $10,000
Credit: Prepaid Insurance $10,000
2. Journal Entry for Restricted Fund Balances
Explanation
Restricted fund balances are constrained by external parties such as laws, grantors, or creditors. These funds must be used for specific purposes, and the corresponding journal entries ensure the proper recording and use of these resources. When funds are received and expended in compliance with these restrictions, the appropriate journal entries reflect this movement.
Sample Journal Entries
Grant Funds Restricted for School Construction
When a government receives grant funds restricted for a particular project, such as school construction, the entry is recorded as restricted revenue. As the funds are spent on the intended purpose, the appropriate expenditure is recorded.
- Receipt of Restricted Grant Funds:
Debit: Cash $200,000
Credit: Revenue – Restricted Grant $200,000
- Expenditure for School Construction:
Debit: Expenditure – Construction $150,000
Credit: Cash $150,000
3. Journal Entry for Committed Fund Balances
Explanation
Committed fund balances represent amounts set aside by formal action from the government’s highest decision-making authority. These funds are dedicated to specific purposes, such as capital projects, and cannot be redirected without further formal action.
Sample Journal Entries
Legislative Commitment for Capital Projects
When the government formally commits funds for capital improvements, an entry is made to reflect the commitment. As the project progresses, expenditures are recorded as they occur.
- Commitment of Funds for Capital Projects:
Debit: Fund Balance – Unassigned $250,000
Credit: Fund Balance – Committed $250,000
- Expenditure on Capital Improvements:
Debit: Expenditure – Capital Projects $100,000
Credit: Cash $100,000
4. Journal Entry for Assigned Fund Balances
Explanation
Assigned fund balances are amounts designated for a specific purpose by the government or its managers but without formal commitment. These funds are allocated for intended projects or uses as part of the budgeting process, but they do not carry the same formal legal restrictions as committed funds.
Sample Journal Entries
Internal Assignment for Upcoming Projects
If a government assigns funds for an upcoming equipment purchase, this allocation is recorded. When the funds are used, the expenditure is recorded accordingly.
- Assignment of Funds for Equipment Purchase:
Debit: Fund Balance – Unassigned $150,000
Credit: Fund Balance – Assigned $150,000
- Expenditure for Equipment Purchase:
Debit: Expenditure – Equipment $50,000
Credit: Cash $50,000
5. Journal Entry for Unassigned Fund Balances
Explanation
Unassigned fund balances represent the residual resources available for any general government purpose, primarily in the General Fund. These funds are free from external or internal constraints and are often used to cover operating expenses, emergencies, or leftover balances after other fund balances have been allocated.
Sample Journal Entries
Leftover Funds in the General Fund
At year-end, unassigned balances in the General Fund are recorded to reflect the residual amount available for future spending.
- Recording Leftover Funds in the General Fund:
Debit: Fund Balance – Unassigned $800,000
Credit: Cash $800,000
In cases where unassigned balances are used for operational needs, journal entries would reflect the reduction in the unassigned balance as expenditures occur.
These journal entries illustrate how state and local governments record changes in their fund balances, ensuring proper classification and compliance with legal and internal policies. The careful documentation of fund balances helps maintain transparency and fiscal accountability.
Common Mistakes and Best Practices
Errors in Fund Balance Classification
One of the most common mistakes in governmental accounting is misclassifying fund balances, which can lead to inaccurate financial reporting and misinterpretation of the government’s financial health. Some frequent errors include:
- Incorrectly Classifying Restricted Funds: Governments may mistakenly classify externally restricted funds (such as grants) as committed or assigned, which do not carry the same legal or external constraints. Misclassifying restricted funds can result in the improper use of resources.
- Misidentifying Assigned vs. Committed Funds: Assigned fund balances, which are designated by management for a specific purpose, may be incorrectly classified as committed if there is confusion over whether formal action was taken. Since committed funds require a formal resolution or ordinance, an error in classification can result in the inappropriate allocation of resources.
- Inaccurate Treatment of Nonspendable Assets: Failing to account properly for nonspendable resources, such as inventory or prepaid expenses, can result in overstating the available fund balance. These resources should be clearly separated to avoid the mistaken belief that they are available for spending.
- Misclassifying Unassigned Funds: Governments may overlook fund deficits in other funds, leading to an incorrect classification of unassigned balances. In funds other than the General Fund, negative balances should be reported as unassigned to accurately reflect financial conditions.
Guidelines for Accuracy in Recording and Journalizing Fund Balances
To ensure accuracy when recording and journalizing fund balances, governmental entities should follow several best practices:
- Review All External and Internal Constraints: Properly classify fund balances by carefully examining legal restrictions, grants, and formal commitments. External constraints should always be categorized as restricted, while internally designated resources must be properly classified as either committed or assigned, depending on the level of formality involved.
- Consistent Monitoring and Updates: Fund balances are dynamic, especially for ongoing projects or programs. Governments should regularly update fund balance classifications to reflect new commitments, expenditures, or changes in legal requirements. This helps avoid outdated or inaccurate classifications.
- Use Clear Documentation: All actions related to fund balances, such as assignments, commitments, and restricted funds, should be well-documented. This includes resolutions, ordinances, and budget documents that indicate the intended use of resources.
- Segregate Nonspendable Resources: Ensure that nonspendable assets are separated from spendable fund balances. This distinction helps prevent misreporting of resources that are not available for current use.
- Review Journal Entries Regularly: Governments should periodically review journal entries related to fund balances to ensure they accurately reflect the flow of resources. This is especially important at year-end to avoid misclassifications and ensure the financial statements are accurate.
Importance of Clear Policies and Resolutions for Committed Funds
Having clear policies and formal resolutions for committed funds is essential for ensuring financial transparency and maintaining proper control over government resources. Best practices include:
- Formalize Commitments Through Legal Action: All commitments of resources should be made through formal government action, such as passing a resolution or ordinance. This process ensures that the government’s highest authority has approved the allocation of funds for a specific purpose and that the commitment is legally enforceable.
- Specify the Purpose and Time Frame: Resolutions or ordinances committing funds should clearly define the purpose for which the funds are set aside and specify any time frames or conditions under which the funds may be used. This ensures that there is no ambiguity about the intended use of the resources.
- Require Formal Action to Reverse Commitments: Once funds are committed, they should not be reallocated without another formal action by the governing body. This prevents the misuse of funds and ensures that financial decisions are made transparently and with proper oversight.
- Maintain Consistent Documentation: Keep thorough records of all committed funds, including the formal actions that established the commitments. This helps avoid confusion or misinterpretation during audits or financial reviews and ensures that the government’s financial statements are accurate.
By following these best practices and avoiding common errors, governments can maintain accurate and transparent financial reporting, ensuring that fund balances are properly classified and reflect the true state of financial resources. Clear policies for committing funds also enhance accountability and help avoid mismanagement of public resources.
Conclusion
Recap of the Fund Balance Categories
In governmental accounting, fund balances are categorized to ensure transparency and proper allocation of resources. The five primary fund balance classifications are:
- Nonspendable: Resources that are not in spendable form, such as inventory or prepaid expenses, and cannot be used to meet current obligations.
- Restricted: Funds that are constrained by external legal requirements, such as grants or laws, which dictate their specific use.
- Committed: Resources set aside by formal government action, such as resolutions or ordinances, for designated purposes like capital projects.
- Assigned: Funds that are designated for a specific use through internal decision-making processes, though not formally committed.
- Unassigned: The residual resources available for any purpose, primarily within the General Fund, offering the greatest flexibility.
These categories help governments manage their finances and ensure that resources are used in alignment with legal and policy constraints.
Importance of Proper Classification and Journalizing for Accurate Financial Reporting
Accurate classification of fund balances is crucial for effective financial reporting and accountability. Misclassifying funds can lead to significant reporting errors, misrepresentation of available resources, and a misunderstanding of the government’s financial health. Properly journalizing entries for fund balances helps maintain transparency and ensures compliance with legal obligations, internal policies, and governmental accounting standards.
Clear and accurate reporting of fund balances enables stakeholders—such as government officials, auditors, and the public—to make informed decisions about resource allocation, budgeting, and financial planning. Additionally, journalizing fund balance changes allows for proper tracking of how and when resources are utilized, ensuring both legal compliance and fiscal responsibility.
Encouragement for Further Study and Understanding of Governmental Accounting Standards (GASB)
Understanding the nuances of governmental fund balance classifications and journalizing practices is critical for maintaining transparency and accountability in state and local government finances. The Governmental Accounting Standards Board (GASB) provides essential guidance through its standards, particularly GASB Statement No. 54, which outlines the framework for categorizing fund balances.
For those studying governmental accounting or preparing for exams, such as the BAR CPA exam, a deeper understanding of GASB standards is vital. By mastering these concepts, accountants and auditors can ensure that government entities adhere to best practices in financial reporting, ultimately contributing to better governance and public trust. Continuous study of GASB standards and their application is key to maintaining professional expertise in this field.
