In this video, we walk through 5 BAR practice questions on reconciling fund balance to net position. 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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Reconciling Governmental Fund Balance to Governmental Activities Net Position
Governmental accounting often requires a reconciliation between the governmental fund financial statements and the government-wide financial statements. The reason is simple: these two sets of statements do not report everything the same way.
Governmental funds focus on current financial resources. They are mainly concerned with resources that are available to spend in the near term. Because of that, governmental funds do not report general capital assets and long-term liabilities in the same way as the government-wide financial statements.
Governmental activities, reported in the government-wide financial statements, use full accrual accounting and the economic resources measurement focus. These statements show the broader financial picture, including long-term assets, accumulated depreciation, and long-term liabilities.
The reconciliation is the bridge between those two views.
Fund Balance to Net Position
One common reconciliation starts with total governmental fund balance and adjusts it to arrive at governmental activities net position. This is essentially a balance sheet-style reconciliation.
Governmental fund balance does not include general capital assets as long-term assets. If a city buys equipment, buildings, or other general capital assets, the governmental fund typically reports the purchase as a capital outlay expenditure when current financial resources are used. The governmental fund does not continue carrying that asset the same way a full accrual statement would.
Governmental activities do report those capital assets. So, when reconciling fund balance to net position, capital assets are added.
However, governmental activities also report accumulated depreciation. Depreciation reduces the carrying amount of capital assets, so accumulated depreciation is subtracted in the reconciliation.
Long-term liabilities work the opposite way. If a government issues long-term bonds or a long-term note, the governmental fund may report the proceeds as an other financing source when the debt is issued. But the governmental fund balance sheet does not continue reporting the long-term liability the same way the government-wide statement of net position does.
Governmental activities do report the long-term debt. Since liabilities reduce net position, long-term liabilities are subtracted when reconciling fund balance to net position.
The basic pattern is:
Governmental fund balance
- Capital assets
− Accumulated depreciation
− Long-term liabilities
= Governmental activities net position
For example, if a city reports governmental fund balance of $480,000, capital assets of $900,000, accumulated depreciation of $250,000, and long-term bonds payable of $375,000, governmental activities net position would be calculated as:
$480,000 + $900,000 − $250,000 − $375,000 = $755,000
The important point is not just the math. The important point is why the adjustment is needed. Governmental funds did not report the capital assets and long-term debt in the same way governmental activities do, so the reconciliation adjusts for that difference.
Change in Fund Balance to Change in Net Position
The second common reconciliation starts with the change in governmental fund balance and adjusts it to arrive at the change in governmental activities net position. This is more like an activity or income-statement-style reconciliation.
The key question is:
Did the governmental funds treat something as a current-period inflow or outflow, even though governmental activities treat it differently under full accrual accounting?
If the answer is yes, an adjustment is probably needed.
For example, capital outlay is reported as an expenditure in governmental funds. If a city buys a capital asset, the governmental funds show an outflow and fund balance decreases. But governmental activities do not treat the full purchase as an expense immediately. The asset is capitalized and then depreciated over time.
Because the governmental funds reduced fund balance for the full capital outlay, the capital outlay is added back when reconciling change in fund balance to change in net position. Depreciation, on the other hand, is subtracted because governmental activities recognize depreciation expense and governmental funds generally do not.
Debt also creates important reconciliation differences. When a government receives debt proceeds, governmental funds report an other financing source. That increases fund balance. But governmental activities do not treat borrowing as revenue. Borrowing creates a liability, not income. So debt proceeds are subtracted in the reconciliation.
Principal payments are the reverse. Governmental funds report principal payments as debt service expenditures, which reduce fund balance. Governmental activities treat principal payments as a reduction of a liability, not an expense. Because the governmental funds reduced fund balance for something that is not an expense in governmental activities, principal payments are added back.
Interest is different. If interest is due and paid during the year, it is often not a reconciling item because it is reported as an expenditure in the governmental funds and as an expense in governmental activities. However, if there is an accrual difference, such as interest incurred but not paid, then an adjustment may be needed.
Asset Disposals
Asset disposals are another common area where the two sets of statements differ.
Governmental funds generally focus on the cash received from selling the asset. If a city sells a general capital asset for $90,000, the governmental funds report the $90,000 as an inflow of current financial resources.
Governmental activities do not report the full cash proceeds as the gain. Instead, they compare the sale proceeds to the asset’s book value.
For example, assume the asset originally cost $150,000 and had accumulated depreciation of $80,000. The asset’s book value is:
$150,000 − $80,000 = $70,000
If the asset is sold for $90,000, the government-wide gain is:
$90,000 − $70,000 = $20,000
The governmental funds increased by the full $90,000, but governmental activities should increase by only the $20,000 gain. That means the fund amount is too high by the asset’s $70,000 book value. The reconciliation subtracts $70,000.
This is why asset disposal questions often focus on book value. The adjustment is not usually the full proceeds, the gain, or the accumulated depreciation by itself. The reconciliation removes the book value so that the full fund inflow is adjusted down to the government-wide gain or loss.
The Main Idea
The main idea behind these reconciliations is not memorizing a list of random additions and subtractions. The main idea is understanding how governmental funds report items differently from governmental activities.
Governmental funds focus on current financial resources. They often report capital outlays, debt proceeds, and debt service payments based on their current-period cash or financial resource effect.
Governmental activities use full accrual accounting. They report capital assets, depreciation, long-term debt, gains and losses, and other long-term economic effects.
Once that difference is clear, the reconciliation becomes much easier to reason through. Capital assets are added because governmental activities report them. Accumulated depreciation and long-term liabilities are subtracted because they reduce net position. Capital outlays and principal payments are added back when reconciling changes because governmental funds treated them as expenditures, while governmental activities treat them as long-term asset or liability items. Debt proceeds are subtracted because borrowing is not revenue. Asset disposals are adjusted so the government-wide statements report only the gain or loss, not the full cash received.
In short, the reconciliation converts the short-term governmental fund view into the full-accrual governmental activities view.
