In this video, we walk through 5 BAR practice questions on fund balance classification for governmental funds. These questions are from BAR content area 3 on the AICPA CPA exam blueprints: State and Local Governments.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Fund Balance Classification for Governmental Funds
Fund balance is a key concept in governmental accounting. In simple terms, fund balance is what remains in a governmental fund after liabilities are subtracted from assets. It shows the resources left in the fund at a specific point in time.
For state and local governments, fund balance is divided into five categories: nonspendable, restricted, committed, assigned, and unassigned. These categories explain how available the resources are and what limits exist on their use.
The easiest way to understand the categories is to think about the level of constraint. Some resources cannot be spent at all. Some can be spent, but only for a specific purpose. Others are set aside by the government itself. And some are available for general use.
Nonspendable Fund Balance
Nonspendable fund balance includes amounts that cannot be spent. This is usually because the resources are not in spendable form, or because they must legally or contractually remain intact.
Common examples include inventory and prepaid items. These are assets, but they are not cash or other spendable financial resources. As an example, a city may have inventory of supplies or prepaid insurance in its general fund. Those items have value, but the city cannot use them to pay current bills.
For example, if a city has $18,000 of inventory and $9,000 of prepaid insurance, the nonspendable fund balance would be:
$18,000 inventory
+ $9,000 prepaid insurance
= $27,000 nonspendable fund balance
The key point is that nonspendable fund balance is not available to spend.
Restricted Fund Balance
Restricted fund balance is spendable, but only for a specific purpose. The restriction must come from outside the government or from law.
Examples include restrictions from grant agreements, bond agreements, creditors, state law, or other external parties. For example, if state law requires a city to use $96,000 only for road repairs, that amount is restricted fund balance. The city can spend the money, but only for road repairs.
Restricted fund balance is different from nonspendable fund balance. Restricted resources are still spendable. They are just limited to a specific use.
A helpful question to ask is: Who created the limitation? If the limitation comes from an outside source or from law, the amount is restricted.
Committed Fund Balance
Committed fund balance is also spendable, but the constraint comes from the government itself. More specifically, the limitation must be created by the government’s highest level of decision-making authority.
For a city, this may be the city council. For a county, it may be the county commission. The commitment usually requires formal action, such as an ordinance or resolution. It also generally must be changed or removed through the same type of formal action.
For example, assume a city council formally sets aside $74,000 by ordinance for a new community center. If the city council is the highest decision-making authority and the ordinance can only be changed by another ordinance, the $74,000 is committed fund balance.
Committed fund balance is different from restricted fund balance because the constraint is internal, not external. Restricted means the limit comes from outside the government or from law. Committed means the government formally limited the resources through its own highest authority.
Assigned Fund Balance
Assigned fund balance is spendable, but the government intends to use it for a specific purpose. This is a weaker constraint than committed fund balance because it does not require formal action by the highest level of authority.
Assigned fund balance may be created by the governing body or by an official who has been given authority to assign fund balance. For example, if a finance director sets aside $38,000 for technology upgrades and city policy allows the finance director to make assignments, that amount is assigned fund balance.
Assigned fund balance is about intent. The government plans to use the money for a specific purpose, but the action is not as formal as a commitment.
Encumbrances often relate to assigned fund balance (and can also relate to committed fund balance). An encumbrance is used when a government issues a purchase order or enters into a contract before the goods or services are received. It helps the government track resources that are expected to be used.
If a city has $24,000 of outstanding purchase orders at year-end and the city council has not formally committed that amount, the amount would usually be assigned fund balance. However, if the outstanding encumbrance is tied to formal action by the highest level of authority, it may be committed instead.
So, encumbrances are usually assigned unless the facts show they were formally committed.
Unassigned Fund Balance
Unassigned fund balance is the leftover spendable amount that has not been classified as nonspendable, restricted, committed, or assigned.
In the general fund, positive unassigned fund balance represents resources available for general use. For example, assume a city’s general fund has total fund balance of $418,000, including:
Inventory: $36,000
Restricted by grant agreement: $87,000
Committed by city council ordinance: $112,000
Assigned by the finance director: $49,000
The unassigned fund balance would be:
$418,000 total fund balance
- $36,000 nonspendable
- $87,000 restricted
- $112,000 committed
- $49,000 assigned
= $134,000 unassigned fund balance
The general fund is the only governmental fund that can report a positive unassigned fund balance. Other governmental funds, such as special revenue funds, capital projects funds, and debt service funds, usually exist for specific purposes. Because of that, their positive fund balances are usually restricted, committed, or assigned.
However, negative unassigned fund balance can appear in other governmental funds. This may happen when a fund has overspent the resources available for its specific purpose.
Final Review
To classify fund balance, start with whether the amount is spendable. Inventory and prepaid items are nonspendable. Amounts limited by law, grants, creditors, or outside parties are restricted. Amounts formally set aside by the government’s highest authority are committed. Amounts set aside for a purpose without that level of formal action are assigned. In the general fund, the remaining positive amount is unassigned.
The main idea is to focus on the source and strength of the constraint. That will usually point you to the correct fund balance classification.
