In this video, we walk through 5 FAR practice questions teaching about determining the appropriate funds for government accounting. These questions are from FAR content area 1 on the AICPA CPA exam blueprints: Financial Reporting.
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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Determining the Appropriate Funds for Government Accounting
In governmental accounting, one of the key tasks for accountants and auditors is determining the appropriate fund(s) that a state or local government should use to record its various activities. Understanding how to properly categorize and account for government transactions is essential for ensuring accurate financial reporting and compliance with legal and financial standards.
Governmental Funds
Governmental funds are used to account for the general operations of a government and are primarily funded by taxes, grants, and other public revenue sources. These funds cover services such as education, infrastructure, and public safety. The most common governmental funds include:
- General Fund: This is the primary operating fund used for general government operations such as public schools, police, and administrative services.
- Special Revenue Funds: These funds are used to account for revenue that is legally restricted to specific purposes, such as road maintenance funded by gasoline taxes or community outreach programs funded by grants. Both the principal and earnings are spent on designated activities.
- Capital Projects Funds: These funds are used for the acquisition or construction of major capital assets, such as new public buildings or infrastructure projects like wastewater treatment plants.
- Debt Service Funds: Used to account for resources set aside to pay long-term debt, such as bond interest and principal.
- Permanent Service Funds: These funds are used when the principal is legally restricted and must remain intact indefinitely. Only the earnings from the principal can be spent for specific public purposes, such as maintaining a park or funding scholarships
Example: A city collects property taxes to operate its schools and provide police services. These activities would be recorded in the General Fund. If the city receives a grant that requires the money to be used exclusively for road repairs, that would be recorded in a Special Revenue Fund.
Proprietary Funds
Proprietary funds are used to account for activities that operate similarly to private businesses, where the government provides goods or services to the public for a fee. These funds are typically used for utilities, transportation systems, and other services where user fees are charged to cover operating costs. The two types of proprietary funds are:
- Enterprise Funds: Used for activities where the public is the primary customer, such as water and sewage utilities, public parking garages, and public transit.
- Internal Service Funds: Used to account for services provided internally within the government to other departments or agencies, such as a government-run printing service or vehicle maintenance shop.
Example: A city operates a parking garage and charges fees to the public for its use. This revenue-generating activity would be recorded in an Enterprise Fund, a type of proprietary fund.
Fiduciary Funds
Fiduciary funds account for resources held by the government in a trustee or custodial capacity for others. These funds cannot be used for the government’s own programs. Fiduciary funds include:
- Pension (and Other Employee Benefit) Trust Funds: These funds account for resources accumulated for employee retirement plans.
- Private-Purpose Trust Funds: Used to report trust arrangements where the government is holding funds for private individuals, organizations, or other governments.
- Custodial Funds: Account for resources that the government temporarily holds and manages on behalf of others, such as tax collections that are later distributed to other entities.
- Investment Trust Funds: These funds account for the external portion of investment pools that are managed by the government on behalf of other governments or entities. In these funds, the government acts as a trustee, managing investments for the benefit of others, while keeping its own portion of the pool separate.
Example: If a city receives and manages scholarship funds donated by a local charity, to be used for specific students, these funds would be recorded in a Fiduciary Fund, specifically a Private-Purpose Trust Fund.
Distinguishing Between Permanent and Special Revenue Funds
Governments sometimes receive donations or grants where either the principal or the earnings (or both) are restricted for specific uses. It is important to distinguish between Permanent Funds and Special Revenue Funds to ensure proper financial reporting.
- Permanent Funds: These funds are used when the principal must remain intact, and only the income (interest or earnings) generated from the principal can be used for specific purposes. For example, a trust fund established to provide scholarships where the principal is permanently restricted, and only the earnings are used for scholarships, would be a Permanent Fund.
- Special Revenue Funds: These funds are used when both the principal and the income are legally restricted for specific purposes. For example, a grant provided to fund community programs where both the principal and the earnings can be spent would be recorded in a Special Revenue Fund.
Example: A philanthropist donates $1 million to a city with the stipulation that only the earnings from the donation can be used to support low-income students. This would be recorded in a Permanent Fund. In contrast, if the donation allows the city to spend both the principal and the earnings on a community health program, it would be recorded in a Special Revenue Fund.
How Many Funds Should a Government Create?
A common question that arises is, “How many funds should a government establish?” The general rule is that a government should create the minimum number of funds necessary to meet legal, accounting, and financial reporting requirements. Creating too many funds can lead to complexity and inefficiency in financial management.
Conclusion
Determining the appropriate fund(s) for recording government activities is a critical task in governmental accounting. By understanding the distinctions between governmental, proprietary, and fiduciary funds, as well as the special uses of permanent and special revenue funds, accountants can ensure accurate financial reporting that complies with legal requirements and provides transparency for public oversight. Governments should maintain a clear and efficient fund structure that reflects their financial activities while avoiding unnecessary complexity.
