BAR CPA Exam: How to Prepare the Statement of Net Position for the Proprietary Funds of a State or Local Government

Introduction

Purpose of the Article

In this article, we’ll cover how to prepare the statement of net position for the proprietary funds of a state or local government. In the realm of state and local government accounting, proprietary funds play a crucial role in tracking the financial activities of entities that operate in a business-like manner. These funds are distinct because they follow accounting practices similar to private-sector enterprises, utilizing full accrual accounting. This article is designed to help those studying for the BAR CPA exam gain a deeper understanding of how to prepare the statement of net position for proprietary funds, which is a core financial statement used by these entities.

The statement of net position is vital as it provides a snapshot of the financial condition of proprietary funds at a given point in time. By understanding this statement, students can more effectively analyze the financial health and obligations of a government entity’s proprietary activities, such as utilities, airports, or public transportation systems. Preparing this statement requires understanding trial balances and how to incorporate supporting documentation to ensure accuracy and compliance with applicable accounting standards, such as those from the Governmental Accounting Standards Board (GASB).

Key Terminology

Proprietary Funds

Proprietary funds are used by state and local governments to account for activities that operate similarly to businesses, where services are provided to the public or other departments in exchange for a fee. There are two types of proprietary funds:

• Enterprise Funds: These are used for services provided to the general public on a user-charge basis, such as utilities or public transit.
• Internal Service Funds: These are used for services provided internally to other governmental departments, such as a central motor pool or information technology services.

Proprietary funds are distinct because they rely on the accrual basis of accounting, recognizing revenue when earned and expenses when incurred, regardless of when cash is received or paid.

Statement of Net Position

The statement of net position is a financial statement that provides a snapshot of the assets, liabilities, deferred inflows, deferred outflows, and net position of an entity at a specific point in time. For proprietary funds, this statement mirrors a balance sheet in private-sector accounting, detailing the overall financial health of the fund. It helps users understand what resources are available to the fund, what obligations it must meet, and how much of its resources are unrestricted for future use.

Trial Balance

A trial balance is a report that lists all the general ledger accounts of an entity and their balances at a specific point in time. For proprietary funds, the trial balance serves as the starting point for preparing financial statements, including the statement of net position. The trial balance must balance, meaning the total debits equal the total credits, and it includes assets, liabilities, revenue, and expenses. It is essential for reconciling accounts and ensuring that all transactions are properly recorded before financial statements are generated.

Supporting Documentation

Supporting documentation refers to the underlying records that substantiate the amounts reported on the trial balance. These may include invoices, contracts, payment records, and other documents that confirm the accuracy of the financial data. Supporting documentation is critical for making adjustments, such as depreciation or reclassification of assets, and ensuring the statement of net position accurately reflects the fund’s financial position.

Understanding these terms is fundamental to accurately preparing the statement of net position for proprietary funds, as they form the building blocks of governmental accounting.

Understanding Proprietary Funds

Definition and Types of Proprietary Funds

Proprietary funds are a category of funds used by state and local governments to account for operations that function similarly to private-sector businesses. These funds use the accrual basis of accounting, where revenues are recognized when earned and expenses are recorded when incurred. Proprietary funds allow governments to better track the financial performance of specific operations that provide goods or services, either to the public or internally within the government, and ensure that those operations are self-sustaining through user fees.

There are two main types of proprietary funds: Enterprise Funds and Internal Service Funds.

Enterprise Funds

Enterprise funds are used to account for services provided by the government to the general public on a fee-for-service basis. These services typically operate similarly to businesses in the private sector, meaning that they generate revenue by charging customers for the goods or services they provide. The goal of an enterprise fund is often to be self-sustaining, with revenues covering the operating expenses, capital expenses, and any debt obligations of the operation.

Examples of enterprise funds include:

• Utilities (e.g., water, electricity, sewer): Governments often provide these essential services to the public and charge users based on their consumption.
• Public transportation (e.g., buses, subways): Public transit systems often charge fees for ridership, which are accounted for in enterprise funds.
• Airports and ports: Governments that operate transportation hubs typically manage these operations through enterprise funds, generating income from landing fees, rentals, and concessions.

Enterprise funds allow governments to ensure that these services are financially self-sufficient and provide transparency regarding their profitability and financial position.

Internal Service Funds

Internal service funds are used to account for services provided internally to other departments, agencies, or components of the government on a cost-reimbursement basis. These funds operate similarly to enterprise funds but serve internal customers rather than the general public. The purpose of internal service funds is to centralize and streamline the management of certain services or functions, making them more efficient and cost-effective.

Examples of internal service funds include:

• Central motor pools: Governments often maintain fleets of vehicles that are available for use by various departments, with costs reimbursed through internal service funds.
• Information technology services: Many governments centralize IT support and infrastructure in a single department, which provides services like network management or software development to other departments.
• Printing and duplicating services: Centralized document management services, including printing and duplicating, are often funded and accounted for using internal service funds.

Internal service funds help governments efficiently allocate resources for shared services, ensuring that the costs of these services are fairly distributed across the departments that use them.

By understanding the distinction between enterprise funds and internal service funds, government financial statement users can better interpret the financial performance of each operation, whether the focus is on external service provision or internal resource management.

How Proprietary Funds Differ from Governmental and Fiduciary Funds

Proprietary funds differ significantly from governmental and fiduciary funds in terms of their purpose, accounting methods, and financial reporting. The primary distinction lies in how these funds operate and the accounting principles they follow. While proprietary funds function more like private-sector businesses, governmental and fiduciary funds serve different roles, with governmental funds focusing on core public services and fiduciary funds managing resources on behalf of others. Understanding these differences is crucial for interpreting financial statements and preparing accurate reports for state and local governments.

Overview of the Accrual Basis of Accounting Used in Proprietary Funds

Proprietary funds follow the accrual basis of accounting, which is the same method used in private-sector financial reporting. Under the accrual basis, revenues are recognized when they are earned, and expenses are recorded when they are incurred, regardless of when cash is received or paid. This accounting method provides a more accurate and comprehensive picture of an entity’s financial position and performance over time.

For proprietary funds, the accrual basis of accounting is particularly useful because it allows these funds to track not only cash flows but also the obligations and resources that will impact future periods. The following characteristics define the accrual basis of accounting in proprietary funds:

• Revenue Recognition: Revenues are recorded when the service is provided, not when payment is received. For example, a government-owned utility company will recognize revenue when water is supplied to customers, even if the customer has not yet paid the bill.
• Expense Recognition: Expenses are recorded when the government incurs an obligation, such as when supplies are received or services are rendered, regardless of when payment is made. For example, salary expenses for employees are recorded when the employees work, not when they are paid.
• Long-term Liabilities and Assets: Proprietary funds report all assets and liabilities, including long-term items like buildings, equipment, and bonds payable. This is key to presenting a full view of the entity’s financial health, allowing users to see the full extent of financial obligations and resources.

Comparison with the Modified Accrual Basis Used for Governmental Funds

In contrast to proprietary funds, governmental funds use the modified accrual basis of accounting, which is designed to reflect the unique financial structure of governmental activities. The modified accrual method focuses more on current financial resources rather than a long-term view of an entity’s financial position. The key differences between the accrual and modified accrual bases are as follows:

• Revenue Recognition in Governmental Funds: Revenues are recognized only when they are both measurable and available. This means that revenue is recorded when the government is reasonably certain it will be received within the current period or soon after. For example, property tax revenue is recognized in governmental funds when it is expected to be collected within 60 days after year-end, rather than when it is billed.
• Expense Recognition in Governmental Funds: Expenditures are generally recorded when the related liability is incurred, but there are exceptions. For example, long-term obligations like debt service payments are recognized only when the payment is due, not when the debt obligation is created. This leads to a focus on current liabilities and excludes long-term obligations that proprietary funds would normally record.
• Capital Assets and Long-Term Liabilities in Governmental Funds: Governmental funds do not record long-term assets (such as infrastructure or buildings) or long-term liabilities (like bonds payable) on their balance sheets. Instead, these are recorded in the government-wide financial statements using full accrual accounting. This difference makes governmental fund statements focus on short-term financial position rather than long-term sustainability, which is the opposite of the approach used by proprietary funds.

Fiduciary Funds

Fiduciary funds, on the other hand, are used to account for resources that a government holds in trust or as an agent for individuals, private organizations, or other governmental units. Like proprietary funds, fiduciary funds also use the accrual basis of accounting. However, the key distinction is that fiduciary funds are not used to support the government’s own programs or operations. Instead, they are used solely to manage assets on behalf of others, and thus the resources in these funds are not available for the government’s own use.

By understanding the different accounting bases used in proprietary, governmental, and fiduciary funds, readers can better comprehend the financial reporting structure for state and local governments and why proprietary funds are uniquely positioned to provide insights into business-like operations within the public sector.

Overview of the Statement of Net Position

Purpose and Structure of the Statement of Net Position

The statement of net position is a key financial statement used to present the financial condition of proprietary funds at a specific point in time. This statement is similar to a balance sheet in the private sector, providing users with a comprehensive snapshot of the fund’s assets, liabilities, and net position. The primary purpose of the statement of net position is to assess the financial health of the fund by showing what it owns (assets), what it owes (liabilities), and the difference between the two, which represents the fund’s net position.

Snapshot of Financial Health at a Specific Point in Time

The statement of net position offers a real-time snapshot of the fund’s financial condition. It reveals the resources available to the fund, the obligations it must meet, and the overall equity that remains after accounting for liabilities. This snapshot helps government administrators, auditors, and other stakeholders evaluate whether the fund is financially sound, capable of meeting its liabilities, and able to continue its operations without needing additional external support.

Components: Assets, Liabilities, Deferred Outflows/Inflows, Net Position

The statement of net position is structured to display four major components:

1. Assets: These are the economic resources that the fund controls, which are expected to provide future benefits. Assets in proprietary funds are typically categorized into current and non-current assets:
   • Current Assets: Resources that are expected to be used or converted into cash within one fiscal year, such as cash and cash equivalents, accounts receivable, and inventory.
   • Non-Current Assets: Long-term resources like capital assets (e.g., buildings, equipment) that are used over an extended period to generate revenue.
2. Liabilities: Liabilities represent obligations the fund owes to external entities and are also categorized as current and non-current:
   • Current Liabilities: Obligations expected to be settled within one fiscal year, such as accounts payable, short-term debt, and accrued expenses.
   • Non-Current Liabilities: Long-term obligations like bonds payable, which will be settled over several years.
3. Deferred Outflows/Inflows of Resources: These are unique to governmental accounting and are used to report consumption (deferred outflows) or acquisition (deferred inflows) of resources that apply to future periods.
   • Deferred Outflows: Represent resources the fund has already spent but that will not be recognized until a future period. For example, payments related to pensions that affect future periods.
   • Deferred Inflows: Represent resources the fund has received but cannot recognize as revenue until a future period, such as unearned revenue.
4. Net Position: This represents the difference between assets and liabilities, adjusted for deferred outflows and inflows. Net position is classified into three categories:
   • Net Investment in Capital Assets: The portion of net position associated with capital assets, net of any related debt.
   • Restricted Net Position: Resources that are constrained by external parties (e.g., creditors, grantors) for specific purposes.
   • Unrestricted Net Position: The portion of net position that is available for general use and not subject to any external restrictions.

Accrual Accounting Methodology

The preparation of the statement of net position follows the accrual basis of accounting, which is also used by private-sector businesses. This method ensures that the statement reflects the fund’s true financial position by recognizing revenue when it is earned and expenses when they are incurred, regardless of when cash transactions occur.

Revenue Recognition and Expense Matching

• Revenue Recognition: Under the accrual method, revenue is recorded when the service is provided or the goods are delivered, even if payment has not yet been received. For example, a government utility fund will recognize revenue from water services at the time the water is provided, not when the customer pays the bill.
• Expense Matching: Expenses are recognized when they are incurred, rather than when payment is made. This means that expenses are matched with the revenues they help generate. For instance, salary expenses for employees working in a public utility are recorded in the period the work is performed, not when the salaries are paid.

This accrual methodology allows the statement of net position to provide a more accurate reflection of a fund’s financial health, capturing both current and future financial impacts, which is essential for decision-making and transparency in government financial management.

Preparing the Statement of Net Position: Key Steps

Step 1: Review and Understand the Trial Balance

Before preparing the statement of net position for proprietary funds, the first and most important step is to review and understand the trial balance. The trial balance serves as the foundation for preparing financial statements and provides the necessary data for compiling the statement of net position. Understanding the format of the trial balance and identifying the key accounts will ensure accuracy in reporting and compliance with accounting standards.

Explanation of Trial Balance Format for Proprietary Funds

The trial balance is a report that lists all the general ledger accounts and their respective debit or credit balances as of a specific date. In proprietary funds, the trial balance includes a comprehensive range of accounts that reflect the accrual-based financial activities of the fund. The trial balance is divided into two main columns: debits and credits, and it must always balance, meaning that the total debits must equal the total credits.

Key characteristics of the trial balance format for proprietary funds include:

• Account Categories: The trial balance for proprietary funds includes accounts for assets, liabilities, and net position (equity). It also lists revenue and expense accounts, though these are not directly included in the statement of net position but may affect the net position by impacting the overall balance.
• Balancing Requirement: The total of all debit balances must equal the total of all credit balances. If they don’t match, it indicates an error in recording transactions.
• Accrual-Based Entries: Since proprietary funds use the accrual basis of accounting, the trial balance reflects both current and long-term assets and liabilities, as well as accrued revenues and expenses.

Identification of Key Accounts: Assets, Liabilities, Equity, and Net Position

When reviewing the trial balance, it’s essential to focus on the key accounts that will be included in the statement of net position. These key accounts fall under the categories of assets, liabilities, and net position (equity), as they represent the core elements of the statement.

1. Assets
   • Current Assets: These accounts include resources expected to be converted into cash or used up within the next year, such as:
     • Cash and Cash Equivalents: Cash held by the proprietary fund, often listed at the top of the trial balance.
     • Receivables: Amounts owed to the fund, such as customer accounts receivable or intergovernmental receivables.
     • Inventories and Prepaid Expenses: Resources like inventories of materials and prepaid costs for future periods.
   • Non-Current Assets: These are long-term resources, such as:
     • Capital Assets: Property, plant, and equipment used in operations (e.g., utility infrastructure).
     • Accumulated Depreciation: A contra-asset account reflecting the depreciation of capital assets over time.
2. Liabilities
   • Current Liabilities: Obligations the fund expects to settle within the next year, including:
     • Accounts Payable: Amounts owed to suppliers or vendors for services or goods received.
     • Accrued Expenses: Expenses incurred but not yet paid, such as accrued salaries or interest payable.
   • Non-Current Liabilities: These are long-term obligations, such as:
     • Bonds Payable: Long-term debt issued to finance capital projects or operations.
     • Other Long-Term Liabilities: Obligations like pension liabilities or other post-employment benefits.
3. Equity and Net Position
   • Net Position: This represents the residual balance after deducting liabilities from assets. In the trial balance, this includes:
     • Net Investment in Capital Assets: Reflecting the capital assets owned by the fund, net of any related debt.
     • Restricted Net Position: Resources that are restricted for specific purposes due to external constraints.
     • Unrestricted Net Position: Resources available for general use by the fund, not subject to external restrictions.

By thoroughly reviewing and understanding the trial balance, preparers can accurately classify and adjust the accounts that will appear on the statement of net position, ensuring a clear and accurate depiction of the fund’s financial status.

Step 2: Classify Assets and Liabilities

Once the trial balance has been reviewed and understood, the next step in preparing the statement of net position is to properly classify the fund’s assets and liabilities. This classification is crucial for accurately presenting the financial position of the proprietary fund, as it helps distinguish between resources and obligations that are short-term (current) versus those that are long-term (non-current).

Current vs. Non-Current Assets

Assets in a proprietary fund are divided into current and non-current categories based on their expected liquidity or use in the business operations. Properly classifying these assets is essential for showing how much of the fund’s resources are readily available to meet its short-term obligations versus how much is invested in long-term capital infrastructure or other resources.

• Current Assets: These are assets that are expected to be converted into cash or consumed within one year or one operating cycle, whichever is longer. The main types of current assets include:
  • Cash and Cash Equivalents: This includes cash on hand, demand deposits, and other highly liquid investments that can be converted into cash within three months or less. It represents the most liquid asset a proprietary fund holds and is often used to settle short-term obligations.
  • Receivables: Receivables are amounts owed to the proprietary fund from external parties. This can include accounts receivable (e.g., customer payments for services such as utilities) and intergovernmental receivables (e.g., payments owed by other governmental units).
  • Inventories: Inventories include goods or materials that the fund holds for future use in operations, such as materials or supplies used in providing services like public utilities. These are current assets because they will be consumed or sold within the fund’s operating cycle.
  • Prepaid Expenses: These are expenses that have been paid in advance for goods or services to be received in future periods, such as prepaid insurance or rent. Since these assets will provide benefits within one year, they are classified as current.
• Non-Current Assets: Non-current assets are long-term resources that are not expected to be liquidated within the next year. These assets typically provide long-term value and are essential to the fund’s operations. Key examples include:
  • Capital Assets: Capital assets consist of property, plant, and equipment used in the fund’s operations. These could include infrastructure like water treatment plants for utilities, public transportation vehicles, or other long-term operational assets. Capital assets are reported net of accumulated depreciation, which represents the portion of the asset’s cost that has been expensed over time due to wear and tear.
  • Long-Term Investments: If the proprietary fund has investments that are not expected to be sold or converted into cash within the next year, they are classified as non-current assets. This can include securities, bonds, or other financial instruments held for long-term financial strategy.

Current vs. Non-Current Liabilities

Similar to assets, liabilities are divided into current and non-current categories based on when the fund expects to settle these obligations. Current liabilities must be paid within one year, while non-current liabilities extend beyond the one-year horizon.

• Current Liabilities: These are obligations the fund expects to settle within one year. Current liabilities typically include:
  • Accounts Payable: This account represents amounts owed by the fund to vendors or suppliers for goods or services already received. For example, a public utility fund may owe money to suppliers for electricity or equipment, and these amounts are typically due within a short time frame.
  • Accrued Expenses: These are expenses that have been incurred but not yet paid, such as accrued wages, interest payable, or taxes payable. Accrued expenses represent short-term obligations that will require cash outflow in the near future.
  • Current Portion of Long-Term Debt: Any portion of a long-term liability (such as bonds payable) that is due within the next year is classified as a current liability. For example, if the fund is required to make a principal payment on a bond within the year, that portion is classified as current, even though the remainder of the bond remains a non-current liability.
• Non-Current Liabilities: Non-current liabilities are long-term obligations that extend beyond one year. These liabilities often represent significant future cash outflows for the proprietary fund and include:
  • Bonds Payable: Bonds payable are long-term debt instruments issued by the fund to finance large capital projects, such as constructing infrastructure or purchasing equipment. These bonds may have repayment terms that span several years or decades, making them a long-term liability.
  • Other Long-Term Debt Obligations: This category includes other forms of long-term debt, such as loans, mortgages, or long-term lease obligations. These are commitments that will not be settled within the current operating cycle but represent future financial obligations of the proprietary fund.

By accurately classifying assets and liabilities into current and non-current categories, the statement of net position provides a clear picture of the fund’s liquidity, solvency, and overall financial health. This classification allows stakeholders to assess whether the proprietary fund has sufficient current assets to cover its short-term obligations and whether it is relying heavily on long-term debt to finance its operations.

Step 3: Analyze Deferred Outflows and Deferred Inflows

Deferred outflows and deferred inflows are unique elements in governmental accounting that affect the financial position of proprietary funds. Understanding these components and properly classifying them is crucial for preparing an accurate statement of net position. These items represent the consumption or acquisition of resources that are related to future periods and must be accounted for in a way that reflects their impact on the fund’s financial performance over time.

Explanation of Deferred Outflows and Deferred Inflows

• Deferred Outflows of Resources: A deferred outflow represents the use of resources that will provide benefits in future periods. It is similar to a prepaid expense in private-sector accounting, but in governmental accounting, it is often tied to long-term obligations, such as pensions or debt refinancing.
  Common examples of deferred outflows include:
  • Pension-Related Deferred Outflows: Government entities often contribute to employee pension plans. However, the expense for these contributions may span several fiscal periods, so the amount related to future periods is classified as a deferred outflow. For instance, changes in actuarial assumptions or differences between expected and actual pension plan performance can result in deferred outflows.
  • Deferred Losses on Debt Refunding: When a government entity issues new debt to refund old debt at a lower interest rate, the difference between the carrying amount of the old debt and the reacquisition price can result in a deferred loss. This loss is amortized over the life of the new debt and is reported as a deferred outflow.
• Deferred Inflows of Resources: A deferred inflow represents resources that the fund has received but cannot yet recognize as revenue. It is similar to unearned revenue in private-sector accounting. Deferred inflows typically relate to resources that will be earned or recognized in future periods.
  Common examples of deferred inflows include:
  • Unearned Revenue: This refers to funds received in advance for services that will be provided in a future period. For example, a proprietary fund that operates a public transportation system may sell annual passes to customers in advance. The portion of revenue related to future periods is classified as a deferred inflow.
  • Pension-Related Deferred Inflows: Just as pension plans can generate deferred outflows, they can also create deferred inflows. For instance, if actual investment returns exceed expectations, the excess may be recognized as a deferred inflow and amortized over future periods.

Placement on the Statement of Net Position

Deferred outflows and deferred inflows are placed in distinct sections on the statement of net position, separate from assets and liabilities. This placement reflects their unique nature as resources or obligations tied to future periods.

• Deferred Outflows: On the statement of net position, deferred outflows of resources are typically listed after the asset section. They are treated as a form of “asset-like” item, indicating that the government has already consumed resources that will benefit future periods. These are not classified as traditional assets because they do not represent current resources available for spending, but rather benefits to be realized in the future. Example placement:

Assets
Current Assets:
Cash and Cash Equivalents
Receivables
…
Non-Current Assets:
Capital Assets
…
Deferred Outflows of Resources:
Pension-related Deferred Outflows
Deferred Loss on Debt Refunding

• Deferred Inflows: Deferred inflows of resources are listed after the liability section on the statement of net position. These are not classified as liabilities because they do not represent obligations that the government must settle, but rather resources that the government has received but cannot yet recognize as revenue. Example placement:

Liabilities
Current Liabilities:
Accounts Payable
…
Non-Current Liabilities:
Bonds Payable
…
Deferred Inflows of Resources:
Unearned Revenue
Pension-related Deferred Inflows

The correct placement of deferred outflows and inflows helps provide a clearer picture of a fund’s financial position, ensuring that revenues and expenses are reported in the periods in which they are truly earned or incurred. This practice enhances transparency and ensures compliance with the Governmental Accounting Standards Board (GASB) guidelines, which govern the use and reporting of these deferred resources.

Understanding the Net Position Categories

The net position section of the statement of net position provides valuable insight into the financial health of a proprietary fund. Net position represents the difference between total assets (plus deferred outflows) and total liabilities (plus deferred inflows). It is divided into three distinct categories: Net Investment in Capital Assets, Restricted Net Position, and Unrestricted Net Position. Each category helps stakeholders understand how the fund’s resources are allocated and any limitations on their use.

Net Investment in Capital Assets

Net Investment in Capital Assets reflects the portion of a fund’s net position that is tied to its capital assets, such as buildings, infrastructure, and equipment, minus any outstanding debt associated with those assets. This category represents the resources that are invested in physical assets that are used in the operation of the fund, net of the liabilities incurred to finance those assets.

Calculating Net Investment in Capital Assets

To calculate Net Investment in Capital Assets, the following formula is used:

Net Investment in Capital Assets = Capital Assets – Accumulated Depreciation – Outstanding Debt Related to Capital Assets

• Capital Assets: This includes property, infrastructure, machinery, and other tangible assets used in the fund’s operations.
• Accumulated Depreciation: Over time, the value of capital assets decreases due to wear and tear, and this is captured by accumulated depreciation. It is subtracted from the value of capital assets to reflect the net book value.
• Outstanding Debt: This refers to any debt issued to finance the acquisition, construction, or improvement of capital assets. For example, if a proprietary fund issues bonds to finance the construction of a water treatment plant, the outstanding balance on those bonds is subtracted from the value of the related capital assets.

This category reflects the portion of the fund’s resources that is tied up in capital assets and is not available for general use.

Restricted Net Position

Restricted Net Position represents resources that are subject to external restrictions on how they can be used. These restrictions are typically imposed by external parties, such as creditors, grantors, or laws and regulations, and the funds cannot be used for general operational purposes. Instead, they must be used in accordance with the terms set by the external entities.

Restrictions Imposed by External Parties

External restrictions can come from various sources, including:

• Creditors: When a government entity issues debt, the bondholders may impose restrictions on how the proceeds from the debt issuance or any related revenues must be used. For example, bond covenants may require that certain funds be set aside for debt service.
• Grantors: Funds received from federal, state, or private grants often come with specific terms dictating how the money must be spent. For instance, a grant to improve public transportation may require the proprietary fund to use the funds exclusively for purchasing new buses or upgrading infrastructure.
• Regulatory or Legal Requirements: Certain laws or regulations may impose restrictions on the use of funds, such as environmental mandates that require revenues from a specific activity to be reinvested into related projects.

Restricted Net Position is presented as a separate category in the statement of net position, highlighting the portion of resources that is not freely available to the fund for discretionary purposes.

Unrestricted Net Position

Unrestricted Net Position refers to the portion of the fund’s net position that is not subject to any external restrictions or tied to capital assets. These resources are free of restrictions and can be used for general purposes, such as covering operational costs or addressing unforeseen financial needs. Unrestricted net position gives the fund flexibility in managing its finances and addressing any emerging challenges or opportunities.

Free of External Restrictions and Available for General Use

Unlike restricted net position, unrestricted net position is not bound by external parties, and it can be allocated according to the priorities and needs of the government entity. This category represents the most flexible part of the fund’s financial resources and is critical for maintaining financial stability, as it can be used to cover:

• Day-to-day operating expenses.
• Contingency funding for emergencies or unforeseen events.
• Future capital projects or improvements.

Unrestricted Net Position is often used as a measure of a fund’s financial flexibility and health, as it indicates whether the fund has sufficient resources to cover its operational and strategic needs without relying on restricted or debt-funded assets.

By categorizing the net position into Net Investment in Capital Assets, Restricted Net Position, and Unrestricted Net Position, the statement of net position provides a clearer view of how a proprietary fund’s resources are allocated and how much is available for general use. This breakdown is essential for financial decision-making and long-term planning.

Adjustments from Supporting Documentation

Step 4: Adjustments and Reclassifications Based on Supporting Documentation

After reviewing the trial balance and classifying the assets, liabilities, and net position, the next critical step in preparing the statement of net position is to make necessary adjustments and reclassifications. These adjustments are based on the supporting documentation that provides further details about the financial transactions and ensures that the financial data is accurate and in compliance with accounting standards. This step is essential for aligning the trial balance with the reality of the fund’s financial condition.

Identification of Adjustments (e.g., Depreciation, Allowance for Doubtful Accounts)

Adjustments are made to ensure that the financial data properly reflects the accrual basis of accounting, which is required for proprietary funds. Supporting documentation, such as invoices, contracts, and financial agreements, helps identify areas where adjustments are needed. Common adjustments include:

• Depreciation: Depreciation is the systematic allocation of the cost of a capital asset over its useful life. Supporting documentation for capital assets, such as purchase contracts or asset registries, provides details on the asset’s cost and useful life, allowing for the calculation of depreciation. Depreciation reduces the value of capital assets on the statement of net position and increases accumulated depreciation. This ensures that the fund’s assets are not overstated and reflect their actual worth over time. Example:
  \(\text{Annual Depreciation} = \frac{\text{Cost of Asset}}{\text{Useful Life of Asset}} \)
• Allowance for Doubtful Accounts: This adjustment accounts for the potential that some receivables may not be collected. Supporting documentation, such as aging reports or past collection histories, can provide insight into the percentage of receivables that may be uncollectible. An adjustment is made to reflect the allowance for doubtful accounts, reducing the value of accounts receivable on the statement of net position to a more realistic, collectible amount.
  Example:
  Allowance for Doubtful Accounts = Accounts Receivable x Estimated Uncollectible Percentage

Reclassification of Accounts as Needed (e.g., Capitalizing Assets)

In addition to adjustments, reclassifications may be necessary to ensure that assets and liabilities are correctly categorized. Supporting documentation can reveal instances where transactions were initially misclassified or require a more accurate presentation on the statement of net position. Common reclassifications include:

• Capitalizing Assets: Some expenditures that may initially appear as expenses on the trial balance should be capitalized if they meet the criteria for capitalization (i.e., they provide future economic benefits). For example, the purchase of new machinery for a public utility fund should be reclassified from an expense to a capital asset. The supporting documentation, such as purchase invoices and asset registries, helps confirm the nature of the expenditure and whether it qualifies as a capital asset. Once reclassified, the expenditure is recorded as a capital asset, with depreciation applied over the asset’s useful life, rather than as an immediate expense.
• Reclassifying Debt Payments: If a portion of long-term debt is due within the current fiscal year, it needs to be reclassified from non-current liabilities to current liabilities. Supporting documentation, such as debt agreements or repayment schedules, will indicate which portion of the debt is due within the year and must be reflected as a current liability in the statement of net position.

Explanation of Pension Liability Adjustments (if Applicable)

Pension liabilities represent a significant long-term obligation for many government entities, particularly in proprietary funds with a large workforce. Adjustments to pension liabilities are often necessary based on actuarial reports or pension plan performance. Supporting documentation, such as actuarial valuations or pension plan statements, provides the necessary data to adjust pension-related deferred inflows, deferred outflows, and long-term liabilities.

• Pension Liability Adjustments: Pension liabilities are based on the present value of future pension obligations owed to employees. Actuarial reports provide updated estimates on the plan’s financial health, including changes in assumptions (e.g., discount rates, life expectancy) or differences between expected and actual investment returns. These changes may result in deferred outflows or inflows that need to be adjusted on the statement of net position. For instance, an actuarial loss due to changes in pension assumptions may result in an increased pension liability and a corresponding deferred outflow of resources. Adjustments related to pensions ensure that the long-term liability accurately reflects the future obligation to employees and complies with accounting standards such as GASB 68, which governs pension reporting in governmental accounting.

By making these adjustments and reclassifications based on supporting documentation, the statement of net position is more accurate and reliable, reflecting the true financial position of the proprietary fund. These steps are crucial for ensuring compliance with accounting standards and providing a transparent view of the fund’s financial health.

Example: Preparing the Statement of Net Position from Trial Balance

Trial Balance Example

To demonstrate the process of preparing a statement of net position for a proprietary fund, we’ll start with a simplified example of a trial balance. The following is a hypothetical trial balance for a public utility fund as of December 31, 202X:

Account	Debit	Credit
Cash and Cash Equivalents	$150,000
Accounts Receivable	$80,000
Allowance for Doubtful Accounts		$5,000
Inventory	$50,000
Capital Assets	$1,200,000
Accumulated Depreciation		$400,000
Accounts Payable		$40,000
Accrued Expenses		$30,000
Bonds Payable (current portion)		$50,000
Bonds Payable (non-current)		$600,000
Deferred Outflows – Pension	$40,000
Deferred Inflows – Pension		$15,000
Net Position – Net Investment in Capital Assets		$800,000
Net Position – Unrestricted		$80,000
Totals	$1,520,000	$1,520,000

Preparation of Statement of Net Position

Using the trial balance, we will prepare the statement of net position for this proprietary fund. The process involves classifying the accounts into assets, liabilities, deferred inflows/outflows, and net position categories, and ensuring everything balances properly.

Step-by-Step Process of Creating the Statement

1. Assets
   • Current Assets:
     • Cash and Cash Equivalents: $150,000
     • Accounts Receivable: $80,000 (less $5,000 for Allowance for Doubtful Accounts)
     • Inventory: $50,000 Total Current Assets:
       150,000 + (80,000 – 5,000) + 50,000 = 275,000
   • Non-Current Assets:
     • Capital Assets: $1,200,000
     • Less: Accumulated Depreciation: $400,000
       Net Capital Assets:
       1,200,000 – 400,000 = 800,000
       Total Non-Current Assets: $800,000
       Total Assets = $275,000 (Current) + $800,000 (Non-Current) = $1,075,000
2. Deferred Outflows of Resources
   • Deferred Outflows – Pension: $40,000
     Total Deferred Outflows of Resources = $40,000
3. Liabilities
   • Current Liabilities:
     • Accounts Payable: $40,000
     • Accrued Expenses: $30,000
     • Bonds Payable (current portion): $50,000 Total Current Liabilities:
       40,000 + 30,000 + 50,000 = 120,000
   • Non-Current Liabilities:
     • Bonds Payable (non-current portion): $600,000 Total
       Non-Current Liabilities: $600,000
       Total Liabilities = $120,000 (Current) + $600,000 (Non-Current) = $720,000
4. Deferred Inflows of Resources
   • Deferred Inflows – Pension: $15,000
     Total Deferred Inflows of Resources = $15,000
5. Net Position
   • Net Investment in Capital Assets:
     1,200,000 – 400,000 – 600,000 = 200,000
     This reflects the capital assets less accumulated depreciation and the portion of the bonds payable related to capital assets.
   • Unrestricted Net Position: $80,000 (as listed in the trial balance)
     Total Net Position = $200,000 (Net Investment in Capital Assets) + $80,000 (Unrestricted) = $280,000

Final Statement of Net Position

Based on the classification and calculations, the Statement of Net Position for the public utility proprietary fund as of December 31, 202X would appear as follows:

Statement of Net Position	December 31, 202X
Assets
Current Assets	$275,000
Non-Current Assets	$800,000
Total Assets	$1,075,000
Deferred Outflows of Resources
Deferred Outflows – Pension	$40,000
Total Deferred Outflows of Resources	$40,000
Liabilities
Current Liabilities	$120,000
Non-Current Liabilities	$600,000
Total Liabilities	$720,000
Deferred Inflows of Resources
Deferred Inflows – Pension	$15,000
Total Deferred Inflows of Resources	$15,000
Net Position
Net Investment in Capital Assets	$200,000
Unrestricted	$80,000
Total Net Position	$280,000

Highlighting How Each Account is Classified and Reflected in the Statement

• Current Assets include liquid assets like cash and accounts receivable, less any doubtful accounts, and items that will be used up within a year (inventory).
• Non-Current Assets consist of long-term assets such as capital assets (buildings, infrastructure) minus accumulated depreciation.
• Deferred Outflows represent future resources, such as pension-related outflows.
• Current Liabilities are obligations due within the next fiscal year (accounts payable, accrued expenses, and current bond payments).
• Non-Current Liabilities are long-term obligations, such as bonds payable beyond the current year.
• Deferred Inflows represent resources the fund has received but will recognize in future periods, like pension-related inflows.
• Net Position shows how much is invested in capital assets and the unrestricted resources available for general use.

This example shows the systematic process of transforming a trial balance into a statement of net position, ensuring that all accounts are properly classified and adjusted according to their nature.

Best Practices for Preparing the Statement of Net Position

To ensure accuracy and compliance when preparing the statement of net position for proprietary funds, it is crucial to follow established best practices. These practices not only help create a reliable financial statement but also align the report with regulatory standards, ensuring that the financial data accurately reflects the fund’s financial condition.

Reconciliation of Trial Balance with Supporting Documents

A key step in preparing an accurate statement of net position is reconciling the trial balance with supporting documentation. This process ensures that all financial data is properly recorded, and any necessary adjustments or corrections are made.

Verifying Accuracy with Supporting Documentation (e.g., Invoices, Contracts)

• Cross-Check Entries with Source Documents: Each account in the trial balance should be supported by source documents such as invoices, contracts, payment records, or other documentation. For example:
  • Receivables: Verify customer invoices or intergovernmental agreements to confirm that the amounts owed are accurate and properly recorded in the trial balance.
  • Accounts Payable: Review vendor invoices to ensure that amounts due are correctly listed and correspond to actual obligations incurred.
  • Capital Assets: Validate the acquisition of property, plant, and equipment with purchase contracts, and ensure that depreciation schedules are properly applied based on these assets.
• Review Pension-Related Adjustments: Pension liabilities and related deferred inflows and outflows must be supported by actuarial reports and pension statements. Review these reports to ensure that the correct adjustments have been made and that any deferred inflows or outflows are accurately recorded.
• Reconcile Debt Payments: Compare loan agreements or bond documentation with the amounts listed in the trial balance to ensure that both the current and non-current portions of debt are appropriately classified and reflected.

Reconciling these accounts with supporting documentation ensures that all financial entries in the trial balance are accurate and up-to-date. This reduces the risk of misstatements and ensures that the statement of net position reflects the true financial position of the proprietary fund.

Consistency with Government Accounting Standards Board (GASB) Requirements

The Government Accounting Standards Board (GASB) sets the financial reporting standards for state and local governments, including proprietary funds. Adhering to GASB requirements is essential for preparing financial statements that are transparent, comparable, and compliant with regulatory guidelines.

Overview of Relevant GASB Statements (e.g., GASB 34)

• GASB 34: One of the most critical standards for government financial reporting is GASB Statement No. 34, which established the framework for government-wide financial statements, including proprietary funds. GASB 34 requires that proprietary funds use the accrual basis of accounting and that financial reports include the statement of net position. This standard also provides guidance on how to report capital assets, depreciation, and long-term liabilities, ensuring consistency and transparency.
• GASB 68: This statement provides specific guidelines on how governments should account for pension liabilities. It dictates the recognition of pension-related deferred outflows and inflows, ensuring that pension obligations are properly reported on the statement of net position. Following GASB 68 ensures that long-term pension liabilities are accounted for accurately.
• GASB 63: GASB 63 introduced the concepts of deferred inflows and deferred outflows of resources, which must be reported separately from assets and liabilities. These items are essential for recognizing future inflows and outflows of resources that impact financial statements in later periods.

Importance of Using the Proper Classification for Assets, Liabilities, and Net Position

Adhering to GASB standards ensures that assets, liabilities, and net position are classified correctly and consistently across reporting periods. Proper classification is essential for presenting a clear and accurate picture of the fund’s financial condition.

• Assets: Current and non-current assets must be properly distinguished. Current assets, such as cash and receivables, should be expected to be liquidated within one year, while non-current assets like capital assets should be recorded net of depreciation. GASB standards dictate how these assets should be presented, ensuring clarity for financial statement users.
• Liabilities: Current liabilities, such as accounts payable and the current portion of long-term debt, must be separated from non-current liabilities like long-term bonds payable. Proper classification is crucial for accurately reflecting the fund’s short-term and long-term obligations.
• Net Position: GASB 34 outlines how to categorize net position into three key components: net investment in capital assets, restricted net position, and unrestricted net position. These classifications help stakeholders understand how much of the fund’s resources are tied up in capital assets, subject to external restrictions, or available for general use.

By adhering to GASB guidelines and applying the correct classifications, the statement of net position becomes a reliable financial tool that provides stakeholders with a comprehensive view of the proprietary fund’s financial standing. This consistency not only aids in transparency but also enhances comparability across different reporting periods and entities.

Common Errors to Avoid

When preparing the statement of net position for proprietary funds, accuracy and attention to detail are essential. Even small errors in classification, adjustments, or understanding restrictions can result in significant misstatements that affect the overall reliability of the financial statement. Below are some common errors to avoid when preparing the statement.

Misclassification of Assets or Liabilities

One of the most frequent errors in preparing the statement of net position is the misclassification of assets and liabilities as either current or non-current. Proper classification is crucial for accurately reflecting the fund’s liquidity and long-term obligations.

• Current vs. Non-Current Assets: Assets that are expected to be converted into cash or consumed within one year, such as cash, receivables, or inventory, should be classified as current assets. However, long-term investments, capital assets, and other assets with extended useful lives must be categorized as non-current. Misclassifying long-term assets as current can inflate liquidity, leading stakeholders to believe the fund has more readily available resources than it truly does.
• Current vs. Non-Current Liabilities: Similarly, liabilities that are due within one year, such as accounts payable, accrued expenses, and the current portion of long-term debt, should be classified as current liabilities. Long-term liabilities like bonds payable or pension obligations, which extend beyond one year, should be classified as non-current liabilities. Misclassifying non-current liabilities as current can overstate short-term obligations and cause concern over the fund’s ability to meet its immediate debts.

Forgetting to Adjust for Depreciation and Other Necessary Adjustments

Another common error is neglecting to adjust for depreciation and other necessary financial adjustments. Depreciation, in particular, is a critical adjustment for proprietary funds that invest heavily in long-term capital assets.

• Depreciation Adjustments: Capital assets like infrastructure, buildings, and equipment lose value over time due to wear and tear. Failing to account for depreciation can lead to overstating the value of capital assets on the statement of net position. To avoid this error, it is important to regularly apply depreciation schedules and reduce the value of capital assets by accumulated depreciation, which reflects the true net book value of the assets.
  Example:
  Net Capital Assets = Capital Assets – Accumulated Depreciation
• Other Adjustments: In addition to depreciation, other adjustments, such as the allowance for doubtful accounts (for uncollectible receivables) or amortization of deferred outflows/inflows, should be reflected in the statement. Forgetting these adjustments can overstate assets and distort the financial health of the fund.

Ignoring Restrictions When Categorizing Net Position

Properly categorizing net position is another area prone to errors, particularly when ignoring external restrictions on certain assets or resources.

• Restricted vs. Unrestricted Net Position: Failing to account for restrictions imposed by creditors, grantors, or laws can result in misreporting net position. Restricted resources are those that can only be used for specific purposes, such as funds set aside for debt service, capital projects, or certain operational expenditures mandated by external parties. Ignoring these restrictions and categorizing all resources as unrestricted can mislead stakeholders into thinking that more resources are available for discretionary use than actually exist. Example:
• Restricted Net Position should include funds earmarked for specific projects or restricted by external agreements.
• Unrestricted Net Position reflects the portion of resources that are available for general use, free of external constraints.

By ensuring that restrictions are properly accounted for, the statement of net position provides a clearer picture of the fund’s available resources and obligations.

Avoiding these common errors—misclassification of assets and liabilities, failing to account for depreciation and adjustments, and ignoring restrictions on net position—will help ensure that the statement of net position is accurate, reliable, and compliant with government accounting standards. These measures enhance the transparency and credibility of the financial statements, providing stakeholders with a clear view of the fund’s financial health.

Conclusion

Key Takeaways

When preparing the statement of net position for proprietary funds, accuracy and thoroughness are of paramount importance. This financial statement serves as a crucial tool for assessing the financial health of a proprietary fund, offering a clear snapshot of its assets, liabilities, and net position. Ensuring that all accounts are properly classified, adjustments are made based on supporting documentation, and GASB standards are followed will result in a reliable and compliant financial statement.

The process of creating the statement of net position involves several steps, each requiring careful attention to detail:

• Classifying Assets and Liabilities: Properly distinguishing between current and non-current assets and liabilities ensures an accurate depiction of the fund’s short-term liquidity and long-term financial obligations.
• Adjusting for Depreciation and Other Necessary Adjustments: Failing to account for depreciation and other necessary adjustments can lead to overstating assets and misrepresenting the fund’s financial condition.
• Categorizing Net Position: Understanding and accurately reporting restricted, unrestricted, and net investment in capital assets ensures transparency about the availability of resources for future use.

By maintaining precision throughout the preparation process, financial statement preparers can produce a statement of net position that is not only compliant with accounting standards but also useful for stakeholders who rely on these reports for decision-making.

Reiteration of the Role Proprietary Funds Play in State and Local Government Financial Reporting

Proprietary funds play a unique and vital role in state and local government financial reporting. Unlike governmental funds, which focus on public services financed through taxes and other general revenues, proprietary funds operate more like private businesses. They generate revenue by charging customers for services, and as a result, their financial reporting is governed by the accrual basis of accounting, similar to the private sector.

The statement of net position for proprietary funds provides critical insights into the fund’s financial sustainability, solvency, and capacity to continue delivering essential services to the public. Accurate financial reporting ensures that governments can transparently show how well these business-like activities are being managed, whether it’s a water utility, transportation system, or internal service like IT support.

In summary, the preparation of the statement of net position for proprietary funds is not just a compliance exercise, but a key part of ensuring fiscal responsibility and transparency in public sector financial management.