Governmental Fund Accounting for FAR CPA Exam

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In this post and video, we’ll cover governmental fund accounting by jumping straight into 5 example problems like you’ll see on the FAR CPA exam. The practice problems I have lined up will kind of take us from the top of this concept through to the some of the deeper parts of it. So starting with example problem one:

Categories of Governmental Funds


Which of the following is not one of the 3 categories of funds used in governmental accounting?

  • Governmental funds
  • Encumbrance funds
  • Proprietary funds
  • Fiduciary funds

So just take a second and just read through those and make your best guess. That’s all you’re trying to do at this point.

So the answer is encumbrance funds. So it was asking which of the following is not one of the three categories of funds used in governmental accounting? 

So the explanation is the three categories of funds used in governmental accounting are governmental funds, proprietary funds and then fiduciary funds. 

Governmental funds use the modified accrual basis of accounting that focuses on the flow of current financial resources. They are used primarily for non-exchange revenues, such as taxes or grants, revenues between other funds. These are funds that are used for the primary functions of the government, such as health and safety, infrastructure such as building roads or just general government administration. 

Then you have proprietary funds and these operate like a for profit business and they engage in exchange transactions, meaning, users are charged for goods or services just like a regular business. These funds and fiduciary funds use accrual accounting, which focuses on the flow of economic resources versus current financial resources. So that’s accrual accounting. 

Fiduciary funds, these are funds that are held for other entities or individuals. And these funds do not belong to the governmental entity. These funds, like I said, also use accrual accounting. There are, there is no such thing as an encumbrance fund. 

Encumbrance accounting is the term for, for the way that governments track and account for purchases against a budget. 

Governmental Fund Accounting

 Which of the following is not a governmental fund?
  • Internal service fund
  • General fund
  • Permanent fund
  • Debt service fund

The answer is the internal service fund. So, again, the question was which of the following is not a governmental fund? So, again, going back to problem one, you have governmental type funds, you have proprietary funds, then you have fiduciary funds. 

Now, within the governmental funds, there are five of those. Those are the general fund, special revenue funds, debt service funds, capital projects funds, and then permanent funds. 

Going down to proprietary funds, again, proprietary funds use accrual accounting. They are for exchange based transactions, meaning some type of users being charged for a product or service. So these are the business type funds. You have enterprise funds, and then internal service funds. 

Then we have the fiduciary funds. There are four types of these. Those are pension trust funds, investment trust funds, private purpose trust funds, and then custodial funds. They used to be called agency funds or there was a fifth type, but it’s all within custodial funds at this point. 

Now, just a memory or a retention tip: from different review courses or other things. I’ve seen all these different mnemonics for these, I guess there’d be five, two and then four. 

So there’s eleven types of funds total across the three categories of funds. But I think what works the best and what will help you the most, instead of just trying to memorize these words, these eleven types of funds, what really helps is to just think about what the words mean. And if you just do that, these all really make sense. 

So, for example, we know that proprietary funds are business type funds. So there are just two types of proprietary funds. And the first type is enterprise. That is kind of just another name for a business, right? We all have that word associated with business. So an enterprise type fund, just remember, that’s a business type fund. And then the second type is an internal service type fund, meaning a service is being provided within or among the different government funds or accounts or parts of the government, and a service fee or a fee is being charged to the users for that service. So internal service, just think of a business providing a service. So for the two proprietary funds, you have enterprise funds and internal service funds. 

Then with the fiduciary funds, we know that the fiduciary funds, the purposes for the government entity to hold funds for some other entity or persons. And so each of the names of the fiduciary funds, they have the word trust in the name of the fund. So something being held in trust for somebody else. The three types do, and then custodial funds, which is a different way of saying that, right? Funds being held in custody for another party. So pension trust funds, investment trust funds, private purpose trust funds, and then custodial funds. Those are all – if you just think about the words, you know, you can get this, that it’s a fiduciary type fund. 

The ones that are left, the five that are left, you know that those are the governmental type funds: general fund, special revenue fund, permanent fund, debt service funds, and capital project funds. And that tip will help you a lot across the entire CPA process… Is instead of just seeing a new word that’s kind of a new term to you, and just trying to memorize it, think about what the words mean, because most of the time it will just from a commonsense standpoint, the definition or the term will kind of explain what it means or how it works. And that can just go a long ways to helping you deeply understand things versus just trying to memorize things.

Economic Flow of Resources Measurement Focus


Which of the following funds would use the flow of economic resources measurement focus?

  • Permanent fund
  • Special revenue fund
  • Enterprise fund
  • Debt service fund

Which one would use the flow of economic resources? Now, thinking back, we know that the governmental type funds, they all use the current financial resources measurement focus. 

So this is asking really which one of these is a business type fund? So the permanent fund, we know that that’s a governmental fund. Special revenue is a governmental fund. Enterprise fund is a proprietary fund. So that’s the answer. And then the debt service fund is a governmental type fund. 

So the Enterprise Fund is a proprietary fund which uses accrual accounting. That is the flow of economic resources measurement focus. The governmental funds use modified accrual accounting, which uses the current financial resources measurement focus. What that means – Again, if you think about the words like what is that saying? 

That means, OK, what current financial resources do we have available or will we have available, within the current period to cover the current period’s obligations? That’s really what that means. And then on the other hand, the proprietary funds and fiduciary funds, they use accrual accounting, which focuses on the flow of economic resources. So the flow of economic resources, it’s not just talking about financial – and that’s the distinction. 

What are all of our cash and non-cash assets and obligations, both in the short term and long term? So that’s the difference between the current financial resources measurement focus and the flow of economic resources measurement focus. 

Fixed Assets in Governmental Funds


For the year ended December 31, Corona City had the following expenditures from the general fund during the year:

  • $10,000 on new furniture for the city hall
  • $20,000 on a new copy machine

What amount would be listed for fixed assets on the general fund balance sheet for these expenditures at year end?

  • $0
  • $10,000
  • $20,000
  • $30,000

The answer is zero. That would not be listed. Here’s why. Now, while proprietary funds would list fixed assets in its fund balance sheets because they are like a business type fund, they use accrual based accounting. 

Governmental funds – assets are classified as general fixed assets, and they are not listed as part of the fund balance, because governmental funds use the current financial resources measurement focus. Remember we said, what that really means is what financial resources do we have currently or will we have in the current period, to cover our obligations for the current period? 

So for money spent on these machines or furniture, those are no longer financial resources that can be spent. So they’re not tracked as such within the governmental type funds. These general fixed assets, they would be listed in the governmental activity column in the government wide financial statements. But again, not in the fund balance because it’s not a financial resource that’s available to be spent. 

So the accounting equation for governmental funds is current financial assets, plus deferred outflow of resources, minus current liabilities, minus deferred inflows of resources. That leaves you with the fund balance. So there’s nothing about fixed assets in there. 

So another thing related to this type of question, basically just a different way of asking this, that you could see a question on, it would say something like: which of the following funds would record depreciation? And it’s the same thing. Only the proprietary funds which use accrual accounting and the economic resources measurement focus would record depreciation of fixed assets. 

Minimum Number of Funds for Governments


A newly incorporated city is setting up their fund structure. For a population of 200,000, what is the minimum number and types of funds required to be established?

  • At least a general fund and a special revenue fund
  • At least a general fund and a debt service fund
  • At least a general fund, a proprietary fund, and a custodial fund
  • The minimum number of funds required by law and sound financial administration

Now, this is one of those things where there are a lot of topics on the CPA exams where the right answer will be basically a flowery way of saying “it depends.” That – that’s going to be the answer to a lot of things. And they pull in kind of definitions specific to that topic. 

But really, it’s saying it depends. And this is one of those cases. So the answer is the minimum number of funds required by law and sound financial administration. So this is one of those conceptual ideas are almost just a definition that you just need to know. And again, this is basically saying “it depends,” right? 

That’s basically what that is. So here’s the specific language: Governmental units should establish and maintain those funds required by law and sound financial administration. Only the minimum number of funds consistent with legal and operating requirements should be established, however, because unnecessary funds result in inflexibility, undue complexity and inefficient financial administration.

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