BAR CPA Exam: How to Prepare the Statement of Revenues, Expenses, and Changes in Fund Net Position for the Proprietary Funds of a State or Local Government

Introduction

Brief Overview of Proprietary Funds in State and Local Government Accounting

In this article, we’ll cover how to prepare the statement of revenues, expenses, and changes in fund net position for the proprietary funds of a state or local government. Proprietary funds are a crucial component of state and local government accounting, representing operations that function similarly to private businesses. These funds are used to account for government activities that are primarily financed through user charges rather than taxes. Proprietary funds include Enterprise Funds, which cover activities like utilities or public transportation, and Internal Service Funds, which handle services provided internally within the government, such as IT services or vehicle maintenance.

The financial reporting of proprietary funds is distinct from governmental funds because they follow an accrual basis of accounting, similar to private-sector businesses. This method recognizes revenues when they are earned and expenses when they are incurred, providing a clearer picture of the financial position and operations of the fund. The goal of proprietary fund reporting is to demonstrate the fund’s ability to generate revenue sufficient to cover its operational costs and meet other financial obligations.

Purpose of the Statement of Revenues, Expenses, and Changes in Fund Net Position

The Statement of Revenues, Expenses, and Changes in Fund Net Position is one of the core financial statements prepared for proprietary funds. Its purpose is to provide a detailed account of how the fund’s financial position has changed over a period. Specifically, this statement highlights the revenues generated by the fund, the expenses incurred during operations, and any other activities, such as transfers or capital contributions, that affect the fund’s net position.

This statement helps stakeholders understand whether the proprietary fund is operating efficiently and generating enough revenue to cover its costs. It also provides insight into non-operating items, such as investment income or interest expenses, that can impact the overall financial health of the fund. By reviewing this statement, government officials and external stakeholders can assess the fund’s ability to maintain its operations and fund future activities.

Importance of Understanding the Unique Reporting for Proprietary Funds

Proprietary fund accounting differs from governmental fund accounting due to its focus on the full accrual basis, which more closely resembles the reporting standards for private enterprises. For this reason, it is essential for those preparing or analyzing the financial statements of a state or local government to understand the nuances of proprietary fund reporting. These funds are often subject to a higher level of scrutiny because they operate as self-sustaining entities, relying on user fees and other charges to maintain operations.

Understanding the unique reporting requirements ensures accurate presentation of the fund’s financial condition, which is vital for transparency, accountability, and decision-making by public officials, auditors, and citizens. Misreporting or misunderstanding the financial activities of proprietary funds could lead to incorrect conclusions about a government’s financial health and its ability to provide essential services.

The Statement of Revenues, Expenses, and Changes in Fund Net Position is a critical tool for understanding how well a proprietary fund is managing its resources and supporting its operations, making it essential for anyone involved in government accounting to master its preparation and interpretation.

Overview of Proprietary Funds

Definition and Characteristics of Proprietary Funds

Proprietary funds are a category of funds used in state and local government accounting to report on operations that resemble private-sector business activities. These funds account for services provided by the government to either external customers or internal departments, and the operations are primarily financed through user fees or service charges. Unlike governmental funds, which rely heavily on taxes, proprietary funds are self-sustaining and must generate sufficient revenue to cover the costs of providing goods or services.

The key characteristics of proprietary funds include:

• Self-sustainability: These funds operate like private businesses, generating revenue through fees and charges for services rendered.
• Accrual accounting: Proprietary funds follow the full accrual basis of accounting, which recognizes revenues when earned and expenses when incurred, providing a more complete picture of financial performance.
• Focus on net position: Proprietary funds aim to maintain or increase their net position, which reflects the difference between assets and liabilities, similar to equity in private business accounting.

Proprietary funds are divided into two main types based on the services provided and the nature of their operations.

Types of Proprietary Funds: Enterprise Funds vs. Internal Service Funds

There are two types of proprietary funds in governmental accounting: Enterprise Funds and Internal Service Funds.

1. Enterprise Funds:
   • Purpose: Enterprise funds are used to account for operations that provide services to the public and are financed primarily through user charges. Examples include utilities (water, electricity), public transportation, airports, and municipal hospitals.
   • Characteristics: These funds are typically self-supporting, meaning that the user fees collected are expected to cover both operational costs and capital improvements. Enterprise funds are often subject to public scrutiny because they affect the availability and pricing of essential services.
2. Internal Service Funds:
   • Purpose: Internal service funds account for activities that provide services to other departments or agencies within the government itself, rather than to the general public. Common examples include centralized information technology services, fleet management, and printing services.
   • Characteristics: Internal service funds are established to enhance operational efficiency by centralizing services and distributing the costs among the benefiting departments. The goal is to recover costs, and these funds are typically charged back to the departments they serve on a cost-reimbursement basis.

Both types of proprietary funds are similar in their use of accrual accounting and their need to demonstrate financial sustainability, but they differ in the stakeholders they serve—enterprise funds serve the public, while internal service funds serve the government internally.

Financial Reporting Objectives for Proprietary Funds

The financial reporting objectives for proprietary funds are similar to those of private businesses, with an emphasis on providing a comprehensive view of the fund’s financial condition and operational performance. The primary objectives include:

1. Demonstrating financial sustainability:
   • Proprietary funds must show whether they can generate sufficient revenues to cover expenses and continue providing services. This is critical for enterprise funds, where the ability to maintain operations depends on user fees, and for internal service funds, which must demonstrate efficient cost recovery.
2. Accountability and transparency:
   • Governments must ensure that they are providing essential services at a reasonable cost, making the financial performance of proprietary funds a key area of interest for citizens, oversight bodies, and financial regulators.
3. Evaluating operational efficiency:
   • Financial reports for proprietary funds allow stakeholders to assess the fund’s operational efficiency, identifying areas where cost control or revenue enhancements may be necessary.
4. Supporting decision-making:
   • The financial data provided by proprietary fund reports assist government officials in making decisions regarding rate setting, resource allocation, and capital improvements.

By achieving these financial reporting objectives, proprietary funds provide crucial information for assessing their economic viability and ensuring that government operations are conducted effectively and transparently.

Components of the Statement of Revenues, Expenses, and Changes in Fund Net Position

Revenues

Revenues are a central component of the Statement of Revenues, Expenses, and Changes in Fund Net Position for proprietary funds. They represent the inflows of financial resources that the fund earns from providing services. Proprietary funds use an accrual basis of accounting, which means revenues are recognized when earned, regardless of when cash is received. This section of the statement highlights the financial performance of the fund in terms of revenue generation, crucial for assessing its sustainability.

Operating vs Non-Operating Revenues

Revenues in proprietary funds are divided into two key categories: operating revenues and non-operating revenues.

• Operating Revenues:
  • These revenues are derived directly from the principal operations of the fund. For enterprise funds, operating revenues come from providing services to the public, while for internal service funds, they result from services provided to other governmental departments or agencies.
  • Examples of operating revenues include:
    • User fees or service charges for water, electricity, or transportation (enterprise funds)
    • Fees charged to internal departments for IT services or vehicle maintenance (internal service funds)
  • Operating revenues are critical to the sustainability of proprietary funds, as they reflect the fund’s ability to cover operating expenses through its primary activities.
• Non-Operating Revenues:
  • Non-operating revenues are inflows of resources that are not related to the core operations of the fund. These may include investment income, interest earnings, or grants.
  • Examples of non-operating revenues include:
    • Interest earned on investments
    • Grants or subsidies from other governmental entities
    • Revenue from one-time events, such as the sale of assets
  • While non-operating revenues are important, they are typically not sustainable sources of income for the ongoing operations of the fund. These revenues are usually supplementary, helping to boost the fund’s financial position but not supporting its primary operational activities.

Common Revenue Sources for Enterprise and Internal Service Funds

The types of revenues generated by proprietary funds depend on whether the fund is an enterprise fund or an internal service fund. Below are the common revenue sources for each type:

1. Enterprise Funds:
   • Service Charges: Enterprise funds primarily generate revenue through service charges to the public. These charges are for services that the government provides in a manner similar to private businesses.
     • Examples include water and sewer charges, public transportation fares, tolls for highways or bridges, and parking fees.
   • Connection Fees: In some cases, enterprise funds may charge connection fees for new customers connecting to services such as water, gas, or electricity.
   • Licensing and Permit Fees: Enterprise funds may collect revenue from permits or licenses associated with their services, such as waste disposal permits or airport landing fees.
2. Internal Service Funds:
   • Interdepartmental Charges: Internal service funds generate revenue through charges to other departments or agencies within the government. These charges reflect the cost of providing centralized services, such as IT support, fleet management, or printing.
     • For example, an IT department may charge individual departments based on the number of users or hours of support provided.
   • Reimbursements: Internal service funds may also receive reimbursements for shared costs incurred on behalf of multiple departments, such as bulk purchasing discounts or maintenance services.

In both enterprise and internal service funds, it is essential to differentiate between operating and non-operating revenues, as this distinction provides insight into the fund’s core financial performance. Operating revenues are especially critical because they reflect the fund’s ability to sustain itself through its primary activities, which is a key focus for decision-makers and external stakeholders.

Expenses

Expenses represent the outflows of financial resources related to the operations and activities of proprietary funds. Like revenues, expenses in the Statement of Revenues, Expenses, and Changes in Fund Net Position are categorized into operating and non-operating expenses, providing a clear picture of the costs associated with running a government’s business-type activities.

Operating vs Non-Operating Expenses

• Operating Expenses:
  • Operating expenses are those directly tied to the core operations of the proprietary fund. These expenses reflect the cost of providing goods and services to the public (enterprise funds) or to other government departments (internal service funds).
  • Operating expenses are incurred regularly and include items such as salaries, supplies, and utilities—costs that are essential to the day-to-day functioning of the fund.
  • Examples of operating expenses include:
    • Salaries and wages of employees
    • Utilities such as electricity, water, and gas for operating facilities
    • Supplies needed to deliver services, such as parts for vehicle repairs or chemicals for water treatment
    • Contracted services for external vendors who provide maintenance or specialized services
    • Depreciation on capital assets used in operations, such as buildings and equipment
• Non-Operating Expenses:
  • Non-operating expenses are not related to the primary activities of the proprietary fund and often arise from financial transactions, capital investments, or external factors.
  • These expenses can include interest payments, losses on asset disposals, and other financing-related costs.
  • Examples of non-operating expenses include:
    • Interest expense on debt issued to finance capital projects or infrastructure
    • Losses on the disposal of capital assets, such as selling obsolete equipment at a loss
    • Investment losses if funds held in reserve are invested in financial markets and decrease in value
  • Although non-operating expenses are significant, they are typically less frequent than operating expenses and do not represent the ongoing cost of running the fund’s primary operations.

Types of Expenses

Proprietary funds incur a variety of expenses that can be grouped into categories based on the nature of the costs. Understanding these expense categories is essential for accurately preparing the financial statement.

• Salaries and Wages:
  • Salaries and wages are typically the largest operating expense in any government operation. This category includes payments to employees for their labor, including administrative, maintenance, and service personnel. Salaries also include associated costs such as overtime and employee benefits like health insurance and pensions.
• Supplies and Materials:
  • This expense covers the costs of goods and materials necessary for delivering services. Examples include office supplies, repair parts for vehicles or machinery, chemicals for water treatment, and fuel for government vehicles. Supplies are critical for maintaining operations and delivering services efficiently.
• Depreciation:
  • Depreciation is a unique non-cash operating expense that reflects the allocation of the cost of capital assets over their useful life. For proprietary funds, depreciation is recorded for buildings, equipment, vehicles, and infrastructure. This expense represents the wear and tear on assets over time, helping governments plan for future replacements.
• Utilities:
  • Utilities such as water, electricity, gas, and communications (phone or internet) are key expenses for proprietary funds. For instance, an enterprise fund managing a public water utility will incur significant utility costs to operate its facilities and equipment.
• Contract Services:
  • Government operations often rely on third-party vendors to provide specialized services or handle temporary needs. These contracted services might include legal, accounting, IT support, or equipment maintenance. These expenses allow proprietary funds to access specialized expertise without maintaining the service in-house.
• Interest Expense:
  • Interest expense is a non-operating cost associated with debt used to finance capital improvements or other long-term projects. Many proprietary funds finance large infrastructure projects (e.g., water treatment plants or public transportation systems) with bonds, making interest payments a significant non-operating expense.

By clearly differentiating between operating and non-operating expenses and understanding the types of expenses incurred, the Statement of Revenues, Expenses, and Changes in Fund Net Position provides a comprehensive view of the costs of operating proprietary funds. This clarity allows stakeholders to assess the financial health and operational efficiency of the fund.

Changes in Fund Net Position

The net position of a proprietary fund represents the difference between its assets and liabilities, similar to equity in the private sector. Changes in the net position are a critical measure of a fund’s overall financial health and are influenced by revenues, expenses, capital contributions, transfers, and other special items. The Statement of Revenues, Expenses, and Changes in Fund Net Position provides insight into how these factors collectively impact the proprietary fund’s net position during the reporting period.

How Changes in Revenues and Expenses Impact Fund Net Position

Revenues and expenses are the primary drivers of changes in the fund’s net position. A fund’s ability to maintain or grow its net position depends on generating sufficient revenue to cover expenses and provide for future operations.

• Revenue Surpluses: When operating and non-operating revenues exceed the total operating and non-operating expenses, the fund experiences a surplus, which increases the net position. This indicates that the proprietary fund is generating enough income to not only cover its operational costs but also reinvest in assets or services.
• Operating Deficits: If expenses exceed revenues, the fund experiences a deficit, reducing the net position. A continued decrease in net position could signal financial instability, requiring adjustments to service fees, cost controls, or other corrective measures.
• Operating Income (Loss): The difference between operating revenues and operating expenses is referred to as the operating income or loss. A positive operating income shows that the core operations are financially sustainable, while a loss may indicate that the fund needs to adjust its fee structure or improve cost efficiency.
• Non-Operating Revenues and Expenses: Non-operating items, such as interest income or expenses, also influence the net position. While these items are less frequent, they can either offset operating losses or exacerbate them, depending on their size.

The net effect of all revenues and expenses is reflected as a change in net position—either an increase or decrease—giving stakeholders a clear picture of the fund’s financial performance.

Capital Contributions, Transfers, and Special Items

In addition to revenues and expenses, several other factors can significantly affect a proprietary fund’s net position, including capital contributions, transfers, and special items.

• Capital Contributions:
  • Capital contributions refer to funds or assets provided to the proprietary fund by external entities, such as other governmental funds, developers, or private parties. These contributions are typically intended to finance long-term infrastructure or capital projects, like the construction of new public facilities or major equipment purchases.
  • For example, a water utility enterprise fund may receive capital contributions to finance the expansion of a water treatment plant. While these contributions do not reflect operating income, they increase the fund’s net position by providing assets for future use without increasing liabilities.
• Transfers:
  • Transfers are interfund transactions that move financial resources between different funds within the government. Transfers may occur for various reasons, such as reallocating surplus funds, covering deficits, or funding specific projects.
  • For example, an internal service fund might receive a transfer from the general fund to cover start-up costs or capital improvements. Transfers increase the receiving fund’s net position and decrease the net position of the transferring fund, but they do not represent revenue earned through operations.
  • It’s important to note that transfers are not considered revenues or expenses but are instead recorded as separate transactions on the statement. These movements can significantly impact the net position without reflecting the fund’s operational performance.
• Special Items:
  • Special items are transactions or events that are unusual in nature and infrequent in occurrence, but not within the fund’s control. These items are reported separately to provide transparency and ensure that stakeholders can assess their impact on the net position.
  • Examples of special items might include:
    • The sale of a major asset at a gain or loss
    • A legal settlement paid out by the fund
    • The forgiveness of a significant debt or liability
  • Special items can have a significant effect on the net position, either positively or negatively, but they are not expected to recur on a regular basis. Including these items separately allows for a clearer understanding of the fund’s routine financial performance versus the impact of unusual events.

The changes in fund net position reflect the overall financial performance of a proprietary fund by accounting for the results of operations (revenues and expenses), capital contributions, transfers, and special items. This comprehensive view helps assess the sustainability and financial health of the fund, providing key insights to decision-makers, auditors, and external stakeholders. A growing net position typically indicates financial stability, while a declining net position may signal challenges that need to be addressed.

Steps to Prepare the Statement

Step 1: Gather Financial Data

The first step in preparing the Statement of Revenues, Expenses, and Changes in Fund Net Position for proprietary funds is to gather all relevant financial data. This data forms the foundation of the statement and must be accurate and complete to ensure that the financial results are properly reflected.

Collecting Financial Records, Including Cash Flow, Revenue, and Expense Reports

To begin, collect the following financial records:

• Revenue reports: These include details of all sources of revenue, both operating (e.g., user fees) and non-operating (e.g., investment income). Ensure these reports provide an accurate breakdown of revenues by category.
• Expense reports: Gather detailed expense reports that cover all operating costs, including salaries, supplies, utilities, depreciation, and non-operating expenses like interest payments. Break down expenses into appropriate categories to facilitate reporting.
• Cash flow statements: While the statement of revenues and expenses uses accrual accounting, reviewing cash flow data helps ensure that the timing of revenue recognition and expense recording aligns with accrual basis principles.
• Other financial documents: This can include interfund transfer records, capital contributions, and documentation of any special items (e.g., asset disposals or legal settlements).

These records provide the detailed information necessary to classify revenues and expenses accurately and calculate the net position of the proprietary fund.

Understanding Accrual Basis Accounting for Proprietary Funds

Proprietary funds follow the accrual basis of accounting, which means that revenues are recorded when earned, and expenses are recorded when incurred, regardless of when cash is received or paid. This differs from the modified accrual basis used for governmental funds, which only recognizes revenues when they are available and measurable.

Understanding and applying the accrual basis is essential for preparing the statement:

• Revenue recognition: Revenue must be recorded in the period in which the service was provided, even if payment has not yet been received.
• Expense recognition: Expenses should be recorded when the obligation is incurred, even if payment has not yet been made. This includes non-cash items like depreciation, which reflects the usage of capital assets over time.

Accurate use of accrual accounting ensures that the financial statement presents a true and fair view of the fund’s financial position and operational performance.

Step 2: Classify Revenues and Expenses

After gathering financial data, the next step is to correctly classify revenues and expenses into operating and non-operating categories. This classification is crucial for understanding the financial health of the proprietary fund, as it separates core operational activities from ancillary or one-time events.

Properly Identifying and Classifying Operating and Non-Operating Revenues/Expenses

• Operating revenues include charges for services, user fees, and any income directly related to the day-to-day operations of the fund. For example, water and sewer charges for an enterprise fund or fees from internal departments for services in an internal service fund would be classified as operating revenues.
• Non-operating revenues include income not derived from core operations, such as interest income, grants, or investment earnings. Non-operating revenues should be recorded separately from operating revenues to give a clear picture of the fund’s main sources of income.
• Operating expenses consist of costs incurred from providing services, including salaries, utilities, supplies, and depreciation. For example, an internal service fund that manages vehicle maintenance would classify the cost of labor, parts, and fuel as operating expenses.
• Non-operating expenses typically include costs such as interest payments on debt, losses on asset disposals, or other financing-related expenses. These should be clearly separated from operating expenses to reflect the financial impact of non-core activities.

Accurate classification ensures the financial statement provides a clear view of how much of the fund’s financial performance is derived from operations and how much comes from ancillary activities.

Segregating Internal vs External Transactions for Internal Service Funds

For internal service funds, it is essential to segregate internal transactions (services provided to other government departments) from external transactions (services provided to outside entities). Since internal service funds are intended to operate on a cost-reimbursement basis for services provided within the government, properly segregating these transactions ensures accurate reporting of the fund’s financial activities.

• Internal transactions: These are revenues and expenses that occur between the internal service fund and other departments within the government. For example, an IT services internal service fund charges different departments for software support or hardware maintenance. These internal transactions should be recorded as operating revenues and expenses.
• External transactions: Occasionally, internal service funds may provide services to external parties, generating revenue from sources outside the government. These external revenues should be classified separately to distinguish them from core internal operations.

By accurately segregating internal and external transactions, internal service funds can present a clear and transparent picture of how effectively they are providing services to other government departments and the extent to which they rely on external revenue sources.

These steps ensure that the Statement of Revenues, Expenses, and Changes in Fund Net Position is comprehensive, accurate, and reflective of the proprietary fund’s operational performance.

Step 3: Calculate Operating Income (Loss)

Once revenues and expenses have been classified, the next step is to calculate the operating income (loss). This calculation is critical in determining how well the proprietary fund’s core operations are performing and whether the fund is generating enough revenue to cover its operating costs.

Importance of Distinguishing Between Operating and Non-Operating Items

In proprietary fund accounting, it is essential to differentiate between operating and non-operating items because they reflect different aspects of the fund’s financial activities.

• Operating items are revenues and expenses directly related to the primary activities of the fund. For an enterprise fund, this would include user fees for services like water or transportation, while for internal service funds, it would involve charges to other government departments for services such as IT support or fleet management.
• Non-operating items, such as interest income or investment earnings, are not directly tied to the fund’s core operations. These items are typically one-time or periodic and are not indicative of the fund’s regular financial performance.

Distinguishing between these items is important because operating income (loss) provides a clearer picture of the fund’s ability to sustain its operations through its primary activities. Non-operating items, while significant, do not reflect the ongoing success or failure of the fund’s operational performance.

Calculating Net Operating Income (Loss)

To calculate net operating income (or loss), use the following formula:

Net Operating Income (Loss) = Operating Revenues – Operating Expenses

This calculation provides a snapshot of the fund’s core financial performance. A positive net operating income indicates that the fund is generating enough revenue from its services to cover operating expenses, while a negative net operating loss suggests that the fund may be underpricing its services or facing inefficiencies that need to be addressed.

For example:

• If an enterprise fund collects $5 million in user fees (operating revenue) and incurs $4 million in operating expenses (salaries, utilities, and supplies), the net operating income would be $1 million.
• Conversely, if the operating expenses exceed the operating revenues, the fund will report an operating loss. In this case, the government may need to consider adjusting fees, reducing costs, or reassessing service delivery strategies.

Operating income (or loss) is a key indicator of the fund’s financial health, highlighting whether it can sustain itself through its primary operations.

Step 4: Report Non-Operating Items

After calculating the net operating income (loss), the next step is to report non-operating items, which include investment income, interest expenses, grants, and other financing activities. These items, while significant, do not arise from the fund’s primary operations and should be clearly distinguished from operating items.

Reporting Investment Income, Interest Expenses, Grants, etc.

Non-operating items are reported separately on the Statement of Revenues, Expenses, and Changes in Fund Net Position to ensure that stakeholders can assess their impact independently of the fund’s core operations. Common non-operating items include:

• Investment Income:
  • Proprietary funds may generate income through investments of surplus cash or reserve funds. This income typically includes interest earned on investments, dividends, or gains from the sale of investments. While investment income can be an important source of additional revenue, it is not part of the fund’s core service delivery and should be reported as a non-operating item.
• Interest Expenses:
  • Many proprietary funds finance capital projects (such as infrastructure improvements) through debt issuance. Interest expenses represent the cost of servicing this debt and should be classified as non-operating because they are financing-related rather than operational. Interest expenses can significantly impact the fund’s net position, especially for funds with large capital assets.
• Grants and Contributions:
  • Grants from other governmental entities, such as federal or state agencies, and contributions from private parties or developers, are typically non-operating revenues. These funds may be used to support capital improvements, special projects, or one-time initiatives and do not arise from the fund’s primary activities. Grants and contributions are essential for many proprietary funds but should be clearly reported as non-operating items.
• Other Non-Operating Items:
  • Additional non-operating items might include gains or losses from the sale of capital assets, one-time settlements, or other infrequent financial events. These items should be reported separately to avoid skewing the fund’s operating results.

Once non-operating items have been recorded, they are added to or subtracted from the net operating income (loss) to determine the change in net position. This final result provides a comprehensive view of the fund’s overall financial performance, including both its operational success and the effects of non-operating activities.

By accurately reporting non-operating items, the financial statement gives stakeholders a complete picture of the fund’s financial health, ensuring that they can differentiate between routine operational results and the impact of non-recurring or external financial events.

Step 5: Determine Changes in Net Position

Once operating income (loss) and non-operating items are accounted for, the next step is to calculate the changes in net position. This process involves factoring in additional transactions that impact the overall financial position of the proprietary fund, such as contributions, grants, transfers, and changes in capital assets.

Contributions, Grants, and Transfers

• Contributions and Grants:
  • These are external financial resources provided to the proprietary fund, usually for capital projects or specific purposes. Contributions and grants do not arise from the fund’s core operations, but they can significantly increase the fund’s net position by providing resources for infrastructure improvements, new services, or special initiatives.
  • For example, a water utility fund might receive a grant to upgrade its treatment plant or a contribution from a developer to expand service lines for a new neighborhood. These funds are reported as non-operating revenues and increase the fund’s net position.
• Transfers:
  • Transfers involve the movement of financial resources between different funds within the government. For instance, a general fund might transfer surplus resources to an enterprise fund to support capital improvements or operational shortfalls.
  • Transfers are not considered revenue or expense; rather, they are recorded separately as adjustments to the net position. Transfers into a proprietary fund increase the net position, while transfers out decrease it. These transactions are crucial for balancing the financial resources between different government functions.

By incorporating contributions, grants, and transfers, the financial statement provides a comprehensive view of the external support and interfund transactions that affect the proprietary fund’s financial standing.

Adjustments for Capital Asset Additions and Retirements

• Capital Asset Additions:
  • Additions to capital assets, such as infrastructure improvements, new facilities, or equipment purchases, also impact the fund’s net position. These assets are long-term investments intended to enhance the fund’s operational capacity. Although capital asset purchases or improvements do not affect immediate operating income, they are included in the overall calculation of net position to reflect the growth of the fund’s assets.
  • The acquisition or construction of capital assets increases the net position, as it represents an investment in future service delivery capabilities.
• Capital Asset Retirements:
  • When a capital asset is retired, sold, or disposed of, the proprietary fund must make adjustments to its net position. If the asset is sold for a gain, the net position will increase; if sold at a loss, it will decrease.
  • Retirements of obsolete or fully depreciated assets may not have a significant financial impact, but major asset disposals, such as selling a large facility or piece of infrastructure, can greatly affect the financial results of the fund.

These capital adjustments help reflect the true value of the proprietary fund’s resources and indicate its capacity for future service provision and infrastructure investment.

Step 6: Prepare Final Statement

The final step in preparing the Statement of Revenues, Expenses, and Changes in Fund Net Position is to format and summarize the information for presentation. The statement should be clear, well-organized, and provide a complete financial picture of the proprietary fund’s performance over the reporting period.

Formatting and Summarizing the Statement for Presentation

To present the statement clearly, follow these key steps:

1. Start with Revenues and Expenses:
   • Begin by listing operating revenues followed by operating expenses, ensuring that each item is classified correctly. The difference between these two figures will yield the net operating income (loss).
2. Report Non-Operating Items:
   • Below the operating section, report non-operating revenues and expenses. These should include items like investment income, interest expenses, grants, and any other non-operating activities. The sum of non-operating items is then added to (or subtracted from) the operating income (loss).
3. Include Contributions, Grants, and Transfers:
   • Contributions, capital grants, and interfund transfers should be recorded in their own section. These items affect the final net position but are separate from the fund’s operating and non-operating activities. Ensure that the impact of both inflows (grants, contributions) and outflows (transfers out) is clearly presented.
4. Factor in Capital Asset Adjustments:
   • Any changes in capital assets, whether through additions or retirements, should be documented to show their effect on the net position. Ensure that gains or losses from the disposal of assets are reported.
5. Calculate the Change in Net Position:
   • After all revenues, expenses, contributions, and transfers are accounted for, calculate the total change in net position for the reporting period. This figure represents the overall increase or decrease in the fund’s net position, indicating its financial performance.
6. Present the Final Net Position:
   • Add the calculated change in net position to the beginning net position (as reported in the previous period) to determine the ending net position. This figure will be reported on the balance sheet and provides a clear indicator of the fund’s financial standing at the end of the reporting period.

Example Layout for the Statement:

Category	Amount
Operating Revenues
– Charges for Services	$X,XXX,XXX
– Other Operating Revenues	$XXX,XXX
Total Operating Revenues	$X,XXX,XXX
Operating Expenses
– Salaries and Wages	$XXX,XXX
– Supplies and Materials	$XXX,XXX
– Depreciation	$XXX,XXX
Total Operating Expenses	$X,XXX,XXX
Net Operating Income (Loss)	$XXX,XXX
Non-Operating Revenues/Expenses
– Investment Income	$XX,XXX
– Interest Expense	($XX,XXX)
– Grants and Contributions	$XXX,XXX
Total Non-Operating Items	$XXX,XXX
Contributions and Transfers
– Capital Contributions	$XXX,XXX
– Transfers In (Out)	($XX,XXX)
Total Contributions and Transfers	$XXX,XXX
Change in Net Position	$XXX,XXX
Beginning Net Position	$X,XXX,XXX
Ending Net Position	$X,XXX,XXX

By following these steps, the final statement will provide a comprehensive view of the proprietary fund’s financial health, showing stakeholders the sources and uses of funds, the operational results, and the overall change in the fund’s net position.

Illustrative Example

To better understand how to prepare the Statement of Revenues, Expenses, and Changes in Fund Net Position, let’s walk through a step-by-step example using sample data for an enterprise fund. This example will cover the calculation of revenues, expenses, and changes in net position for the fictional City Water Utility Fund for the year ending December 31, 2024.

Step-by-Step Example Using Sample Data

Sample Data

• Operating Revenues:
  • Charges for services (water fees): $5,000,000
  • Other operating revenues (connection fees): $200,000
• Operating Expenses:
  • Salaries and wages: $1,200,000
  • Supplies and materials: $500,000
  • Utilities: $300,000
  • Depreciation: $1,000,000
  • Contracted services: $400,000
• Non-Operating Revenues:
  • Investment income: $50,000
  • Capital grants: $500,000
• Non-Operating Expenses:
  • Interest expense on bonds: $200,000
• Transfers:
  • Transfers in from general fund: $150,000
  • Transfers out to capital projects fund: $100,000
• Beginning net position: $6,500,000

Step 1: Calculate Operating Revenues

Start by adding up the total operating revenues. In this example, the City Water Utility Fund earns revenue from water fees and connection fees.

Total Operating Revenues = Water Fees + Connection Fees = 5,000,000 + 200,000 = 5,200,000

Step 2: Calculate Operating Expenses

Next, calculate the total operating expenses, including all direct costs related to running the water utility. These expenses include salaries, supplies, utilities, depreciation, and contracted services.

Total Operating Expenses = 1,200,000 + 500,000 + 300,000 + 1,000,000 + 400,000 = 3,400,000

Step 3: Calculate Net Operating Income (Loss)

Subtract total operating expenses from total operating revenues to calculate the net operating income (loss):

Net Operating Income (Loss) = Total Operating Revenues – Total Operating Expenses = 5,200,000 – 3,400,000 = 1,800,000

The City Water Utility Fund has a net operating income of $1,800,000, indicating that its primary activities are generating more revenue than its operating expenses.

Step 4: Report Non-Operating Items

Now, report non-operating revenues and non-operating expenses. These include items such as investment income, interest expenses, and grants.

Total Non-Operating Revenues = Investment Income + Capital Grants = 50,000 + 500,000 = 550,000

Total Non-Operating Expenses = Interest Expense = 200,000

Step 5: Report Transfers

Record the transfers between funds. In this example, the City Water Utility Fund receives $150,000 from the general fund and transfers out $100,000 to the capital projects fund.

Net Transfers = Transfers In – Transfers Out = 150,000 – 100,000 = 50,000

Step 6: Calculate the Change in Net Position

To calculate the change in net position, add the net operating income, non-operating revenues, and net transfers, and subtract non-operating expenses:

Change in Net Position = Net Operating Income + Non-Operating Revenues – Non-Operating Expenses + Net Transfers
Change in Net Position = 1,800,000 + 550,000 – 200,000 + 50,000 = 2,200,000

Step 7: Determine the Ending Net Position

Finally, add the change in net position to the beginning net position to determine the ending net position:

Ending Net Position = Beginning Net Position + Change in Net Position
Ending Net Position = 6,500,000 + 2,200,000 = 8,700,000

Illustrating Calculation of Revenues, Expenses, and Changes in Net Position

Here’s how the final statement looks based on the above data:

Category	Amount
Operating Revenues
– Charges for Services	$5,000,000
– Connection Fees	$200,000
Total Operating Revenues	$5,200,000
Operating Expenses
– Salaries and Wages	$1,200,000
– Supplies and Materials	$500,000
– Utilities	$300,000
– Depreciation	$1,000,000
– Contracted Services	$400,000
Total Operating Expenses	$3,400,000
Net Operating Income (Loss)	$1,800,000
Non-Operating Revenues/Expenses
– Investment Income	$50,000
– Capital Grants	$500,000
Total Non-Operating Revenues	$550,000
– Interest Expense	($200,000)
Total Non-Operating Expenses	($200,000)
Transfers
– Transfers In	$150,000
– Transfers Out	($100,000)
Net Transfers	$50,000
Change in Net Position	$2,200,000
Beginning Net Position	$6,500,000
Ending Net Position	$8,700,000

This example demonstrates the step-by-step process of calculating revenues, expenses, and changes in net position for a proprietary fund. By following this format, you can accurately prepare the Statement of Revenues, Expenses, and Changes in Fund Net Position and ensure that it reflects the fund’s financial performance over the reporting period.

Key Differences in Reporting Between Enterprise and Internal Service Funds

Revenue and Expense Treatment for Each Type of Fund

The primary distinction between enterprise funds and internal service funds lies in the nature of the services they provide and the way their revenues and expenses are treated in financial reporting.

Enterprise Funds

• Revenue Treatment:
  • Enterprise funds are used to account for operations that provide services to the general public, often on a fee-for-service basis. Examples include public utilities (such as water, electricity, or transportation) and recreational facilities (such as public swimming pools or golf courses).
  • Operating revenues for enterprise funds primarily come from user fees and charges directly related to providing these services. Since enterprise funds operate similarly to private-sector businesses, these revenues are treated similarly to sales revenue in a commercial setting. Non-operating revenues, such as investment income or grants, are recorded separately.
• Expense Treatment:
  • Operating expenses for enterprise funds include the costs of delivering services, such as salaries, supplies, maintenance, utilities, and depreciation of assets. These expenses directly reflect the cost of running the service provided to the public.
  • Non-operating expenses, such as interest on debt issued to finance capital projects, are recorded separately from operating expenses. These typically include financing costs or losses on asset disposals.

Enterprise funds aim to cover their operating expenses through user fees and are expected to generate enough revenue to sustain operations and fund future capital improvements.

Internal Service Funds

• Revenue Treatment:
  • Internal service funds, on the other hand, account for services provided to other governmental departments or agencies rather than the public. Common examples include IT services, vehicle maintenance, and central purchasing operations.
  • Operating revenues for internal service funds come from charges to other departments within the government. These charges are based on cost-reimbursement models, where the fund recovers its costs by billing the departments it serves. Non-operating revenues, such as investment income, are recorded separately and are less common than in enterprise funds.
• Expense Treatment:
  • Operating expenses for internal service funds include the cost of providing services to other departments, such as personnel, supplies, and depreciation of equipment. The primary difference is that the expenses are related to internal operations rather than external public services.
  • Non-operating expenses might include interest on loans or other financing costs but are less common in internal service funds compared to enterprise funds.

Internal service funds are designed to operate on a break-even basis, covering their costs through charges to the departments they serve. These funds focus on providing efficient services to other government entities, and revenue generation is less of a priority than in enterprise funds.

Special Considerations for Interfund Activities in Internal Service Funds

Interfund activities are particularly important in the reporting for internal service funds because these funds exist primarily to serve other government departments. The way these transactions are recorded and reported has a direct impact on both the internal service fund and the departments it supports.

Internal Transactions and Cost Recovery

• Charges for Services:
  • Internal service funds charge other governmental funds or departments for the services they provide, such as IT support or vehicle maintenance. These charges are recorded as operating revenues for the internal service fund and operating expenses for the receiving department.
  • The charges must reflect the actual cost of providing the service to ensure accurate cost recovery and avoid distorting the financial performance of either the internal service fund or the receiving department.
• Cost Allocation:
  • It is critical to allocate the cost of internal services accurately across departments based on usage. For example, an internal service fund providing IT services may allocate costs based on the number of users, hours of support, or the volume of data processed.
  • Proper cost allocation ensures that the financial statements fairly represent the costs incurred by each department and prevent cross-subsidization of services.

Eliminations in Consolidated Financial Statements

When preparing consolidated government-wide financial statements, interfund transactions between internal service funds and other funds must be eliminated to prevent double-counting of revenues and expenses.

• Eliminating Revenues and Expenses:
  • The operating revenues and expenses from internal service funds are recorded as part of the government’s internal operations. In consolidated financial reports, these interfund activities are eliminated to avoid overstating total revenues and expenses for the government as a whole.
• Net Position Allocation:
  • While internal service funds typically operate on a cost-recovery basis, any surplus or deficit at year-end is allocated to the departments that use the services. This ensures that the fund’s net position is accurately reflected and aligned with the departments that incurred the costs.

Interfund Transfers and Reimbursements

• Interfund Transfers:
  • Occasionally, internal service funds may receive transfers from other funds to cover start-up costs or capital investments. These transfers are recorded separately from operating revenues and are considered part of the fund’s overall financing structure.
• Reimbursements:
  • Reimbursements for shared costs, such as bulk purchases made by the internal service fund on behalf of multiple departments, are common. These reimbursements must be properly recorded to ensure that the expenses and revenues reflect the actual cost incurred by the fund and the benefiting departments.

Internal service funds play a critical role in supporting the internal operations of the government, and special attention must be paid to ensure that interfund activities are accurately reported and fairly reflected in both the fund and consolidated government-wide financial statements.

Common Errors to Avoid

When preparing the Statement of Revenues, Expenses, and Changes in Fund Net Position, it is important to avoid common errors that can lead to inaccurate reporting. These errors can distort the financial health of proprietary funds and mislead stakeholders. Below are three critical areas where mistakes often occur, along with strategies for avoiding them.

Misclassification of Revenues or Expenses

One of the most frequent errors is the misclassification of revenues and expenses, particularly in differentiating between operating and non-operating items.

• Operating revenues and expenses are directly related to the core activities of the proprietary fund. For enterprise funds, these revenues come from services provided to the public, such as utility fees. For internal service funds, operating revenues are derived from services provided to other government departments.
• Non-operating revenues and expenses, on the other hand, stem from activities that are not central to the fund’s primary operations. These may include interest income, capital grants, or interest expenses.

How to Avoid Misclassification:

• Review the nature of each revenue and expense item to determine whether it arises from core operations. If the item is not directly related to providing services, it should be classified as non-operating.
• Pay attention to the Governmental Accounting Standards Board (GASB) guidance, which provides clear definitions of operating versus non-operating items.
• Misclassifying items could result in inaccurate reporting of operating income (loss) and distort the fund’s true financial performance.

Failing to Account for Internal Transactions

For internal service funds, failing to account for internal transactions is a common error that can misstate both revenues and expenses. Internal service funds generate revenue by charging other government departments for services, such as IT support or fleet maintenance. If these transactions are not properly recorded, the financial statements will not reflect the true costs and revenues associated with providing these services.

How to Avoid Failing to Account for Internal Transactions:

• Ensure that all charges for services provided to other departments are recorded as operating revenues for the internal service fund.
• Correspondingly, ensure that the receiving departments record these charges as operating expenses. This creates a balanced reflection of interdepartmental services within the government.
• In consolidated government-wide financial statements, eliminate these interfund transactions to prevent double-counting of revenues and expenses.

Neglecting internal transactions can cause significant reporting issues, especially when it comes to accurate cost recovery and transparency in government operations.

Omitting Non-Operating Items Like Interest or Transfers

Another frequent mistake is omitting non-operating items, such as interest income, interest expense, or transfers between funds. These items, while not part of the fund’s operating activities, play a crucial role in determining the overall change in net position.

• Interest income may be earned on invested surplus funds, and interest expense is typically related to debt used to finance capital projects.
• Transfers between funds can occur when one fund provides resources to another, and these need to be properly recorded as they affect the net position of both funds.

How to Avoid Omitting Non-Operating Items:

• Review all financial transactions to ensure that non-operating items, such as investment income or interest payments, are included in the statement.
• Pay particular attention to interfund transfers. Record any transfers in or transfers out separately from operating revenues and expenses, and ensure that they are reflected accurately in the changes to net position.
• Periodically review financial statements to ensure that all non-operating items are appropriately captured and reported.

Omitting these items can lead to an incomplete picture of the proprietary fund’s financial performance, as non-operating revenues and expenses often represent significant cash flows or changes in liabilities.

Avoiding common errors such as the misclassification of revenues and expenses, failing to account for internal transactions, and omitting non-operating items like interest or transfers is essential to ensure the accuracy of the Statement of Revenues, Expenses, and Changes in Fund Net Position. Proper classification, diligent recording of interfund activities, and careful inclusion of non-operating items will provide a true reflection of the proprietary fund’s financial health, enabling better decision-making and transparency.

Conclusion

Recap of the Importance of Accurate and Clear Reporting

The Statement of Revenues, Expenses, and Changes in Fund Net Position is a critical financial document for proprietary funds in state and local governments. Accurate and clear reporting on this statement ensures that stakeholders, including government officials, auditors, and the public, can properly assess the financial health and operational efficiency of a fund. By clearly distinguishing between operating and non-operating revenues and expenses, accounting for interfund transactions, and including capital contributions, grants, and transfers, this statement provides a comprehensive overview of how a proprietary fund’s net position has changed over time.

Misclassifications or omissions on this statement can lead to incorrect conclusions about a fund’s ability to sustain its operations or meet future financial obligations, which underscores the importance of attention to detail and adherence to accounting standards.

How This Statement Supports Decision-Making for State and Local Governments

This financial statement plays a crucial role in supporting decision-making for state and local governments. It provides a detailed view of the fund’s performance, allowing stakeholders to evaluate whether the fund is generating sufficient revenue to cover its expenses and to identify potential areas for cost savings or revenue generation. Moreover, it helps government officials understand the financial impact of non-operating items such as capital investments, grants, and debt financing.

By reviewing the statement, government leaders can make informed decisions regarding budgeting, rate-setting for services, capital improvements, and long-term financial planning. The ability to track changes in net position also supports transparency and accountability, ensuring that public funds are being managed effectively and sustainably.

Encouragement to Practice with Real-World Data or Case Studies

Mastering the preparation of the Statement of Revenues, Expenses, and Changes in Fund Net Position requires practice and real-world application. Practitioners and students are encouraged to work with actual financial data from proprietary funds or study case examples that reflect the complexities of governmental accounting. Analyzing real-world scenarios will help deepen understanding of the nuances in classifying revenues and expenses, accounting for interfund activities, and recognizing the impact of non-operating transactions.

Whether preparing this statement for enterprise or internal service funds, hands-on practice with real or simulated data will reinforce the principles discussed and enhance the ability to produce accurate, transparent, and meaningful financial reports. This skill is invaluable for anyone involved in state and local government financial management or public sector auditing.