Chapter One

Overview of Financial Reporting for Governmental and NFP Entities

Learning Objectives:
 After studying this chapter, you should be able to:
 Identify and explain the characteristics that distinguish governmental
and not-for-profit entities from for-profit entities.
 Identify characteristics and types of government and Not-For-profit
organizations (NFP)
 Identify the authoritative bodies responsible for setting IPSAS and
financial reporting standards for all governmental and not-for-profit
entities.

1.1 Introduction
You have been engaged with the term "accounting" from your previous course and I hope
you could define it. To recapitulate, let us define Accounting as the art of analyzing,
recording, summarizing, evaluating and interpreting an organizations financial activities and
status, and communicating the results thereof. We defined accounting in this form in
previous accounting courses which were totally dealt with profit making organizations. This
course, however, deals with the accounting and reporting concepts, standards, and
procedures applicable to state and local governments including cities, townships, and
villages; federal government; and not-for profit( NFP) institutions such as universities,
hospitals, voluntary health and welfare organizations and other non-profit organizations or
in general for non-business organizations.
Entities or organizations that are established with operating purpose other than profit
making include:
A. Governmental Entities (Government)
B. Nonprofit (NP) Entities
What is a Government?
A government is a body that has the power to make and the authority to enforce rules and
laws within a civil, corporate, religious, academic, or other organization or group. For the
purpose the course Government and NFP Accounting, Government can also be defined as
an entity that provides such major services as administrative, social, economic, and others
either free from charge or with a “token” charge.
A government is an organized entity, which in addition to having governmental character,
has sufficient discretion in the management of its own affairs to distinguish it as separate
from the administrative structure of any other governmental unit. To be regarded as a
government, an entity must possess all three of these critical attributes: existence as an
organized entity, governmental character, and substantial autonomy. Each is
explainedbelow.
1. Existence as an Organized Entity - Evidence of this attribute is provided by the
presence of some form of organization and the possession of some corporate powers,
such as perpetual succession, the right to sue and be sued, have a name, make contracts,
acquire and dispose of property, and the like. Designation of a class of governments in
law as “municipal corporations,” “public corporations,” “bodies corporate and public,”
and the like indicates that such units are organized entities.
2. Governmental Character - this characteristic is indicated where officers of the entity are
popularly elected or are appointed by public officials. A high degree of responsibility to
the public demonstrated by requirements for public reporting or for accessibility of
records to public inspection, is also taken as critical evidence of governmental
character. Governmental character is attributed to any entities having power to levy
property taxes, power to issue debt paying interest exempt from Federal taxation, or
responsibility for performing a function commonly regarded as governmental in nature.
An entity can also be recognized as having governmental character if it meets the
indicated requirements as to officers or public accountability. Thus, some districts or
zonal governments with no taxing powers are recognized as local governments because
of provisions as to their administration and public accountability.
3. Substantial Autonomy - this requirement is met where, subject to statutory/legal
limitations and any supervision of local governments by the state, an entity has
considerable fiscal and administrative independence. Fiscal independence generally
derives from power of the entity to determine its budget without review and detailed
modification by other local officials or governments, to determine taxes to be levied for
its support, to fix and collect charges for its services, or to issue debt without review by
another local government.
Some government agencies having considerable fiscal autonomy are classified as dependent
agencies of another government rather than as governments because of one or more of the
following characteristics:

 Control of the agency by a board composed wholly or mainly of parent

government officials.

 Control by the agency over facilities that supplement, serve, or take the place of
facilities ordinarily provided by the creating government.

 Provision that agency properties and responsibilities revert to the creating

government after agency debt has been repaid.

 Requirements for approval of agency plans by the creating government.

 Legislative or executive specification by the parent government as to the
 location and type of facilities the agency is to construct and maintain.

 Dependence of an agency for all or a substantial part of its revenues on

appropriations or allocations made at the discretion of another state or local
government.

 Provision for the review and the detailed modification of agency budgets by
another local government.
Example of Governments in Ethiopia:
 Federal government of Ethiopia and its agencies
 The eleven Regional State Governments and Two Administrative City councils
 Zonal Level Local Governments, District Level Local Governments,
 Municipality and Town Governments, Keble level local governments i.e.
Keble is the lower level government in Ethiopia.
Government is classified as Special Purpose Government and General Purpose
Governments. The Special Purpose Government is a government that provides a single
service or few services to the citizenry. For Example: Transportation authorities can be
taken as Special Purpose Government Entity. The General Purpose government provides a
wide collection of services to the citizenry. Examples: Federal government, State
governments, zone government, cities, towns, villages, etc.
What is Not-for-profit (NFP) Entity?
NFP Entities are entities other than the government and that provides community services
either free from charge or with a “token” charge. The following are the essentials to classify
an entity as a not for-profit: Legally separate organizations its operating purpose is other
than to provide goods or services at a profit. It may not distribute surpluses. Generating
profit is not an objective outlined in its legislation, regulations or constitution. It does not
pay income tax or income tax equivalents – usually exempt from federal, state, and local
taxation .It is not able to transfer ownership.
Basically,the terms “governmental and not-for-profit," "nonprofit," and even "non business"
have been used to describe organizations that have one basic characteristic in common i.e.
their primary purpose is related to social objectives, not to profit. These organizations may
also have other common characteristics, such as nonprofit tax status, an appointed board,
and for some, oversight of their operations by a governmental agency. Examples of such
governmental and not-for-profits (NFPs) include state and local governmental organizations,
libraries, museums, performing arts organizations, zoological and botanical societies, trade
associations, unions, professional associations, fraternal organizations, private and
community foundations, voluntary health and welfare organizations, social and country
clubs, religious organizations, and public broadcasting stations.
The governmental and not for profit accounting system uses the historic system of fund
accounting which is a set of separate and self-balancing accounts responsible for managing
resources that are assigned to specific purposes based on regulations and limitations. The
governmental and not for profit accounting system has a different focus for measuring
accounting than private sector accounting. Rather than measuring the flow of economic
resources, governmental and not for profit accounting measures the flow of financial
resources. Instead of recognizing revenue when they are earned and expenses when they are
incurred, revenue is recognized when there is money available to liquidate liabilities within
the current accounting period, and expenses are recognized when there is a drain on current
resources.
1.2 Unique Characteristics of Governmental and Other NFP
Organizations
• Absence of profit motive; most tax exempt. The profit motive is not inherent in their
operation or inception. Their main objective is to provide or render more goods and
services to the public or society.
• Constituency (citizen / taxpayer) ownership versus stockholder ownership. They are
usually owned collectively by their constituents; i.e., ownership is not normally
evidenced by individually owned equity shares which may be sold or exchanged.
• No direct relationship between resources received and services provided. Those
contributing financial resources to the organization do not necessarily receive a
direct or proportionate share of its goods or services; for example, the welfare
recipient most likely did not pay the taxes from which this benefit are paid.
• Major policy decisions, and perhaps some operating decisions, typically are made
by consensus vote of an elected or appointed governing body.
 Power ultimately rests in the hands of the people
 People delegate power to public officials through the election process
 Empowered by and accountable to a higher level government
 The organization has the power to tax( government)
 Accounting System: G &NFPs have generally adopted the concepts and systems of
fund accounting.
 Operation of G&NFP entities is mostly diversified. That is, its scope is wide.
Example, consider Gondar Town Municipality, its common operation covers health,
security, administration, investments, constructions and others.
 Consequently, a typical governmental entity’s activities might be categorized in to
three as governmental, proprietary, and fiduciary activities.
i, Governmental activities: are activities that benefit the government or its citizens as a
whole.
  Are activities designed to provide basic governmental services to the general public
includes health and welfare, educational, government administration, police,
recreational, etc.
 Governmental activities are funded or financed primarily by taxes of different types
(such as property, income and sales taxes) and intergovernmental grants.
ii, Proprietary activities:are referred to as business type activities. These are activities
similar to commercial businesses in which goods and services are financed by user charges.
 They commonly include such activities parking and recreational facilities, utilities,
transportation services, sanitation services, stadiums arenas, etc.
iii, Fiduciary Activities: are situations in which the government unit holds resources as a
custodian for entities or individuals outside the governmental unit or for other government
units or funds.
 They are activities which the governmental act as a trustee for other parties.
 In other words, they are activities where the governmental unit holds assets or
resources for other.
1.2.1 Types of Governmental and NFP Organizations
The major types of governmental & not-for-profit organizations may be classified as
follows:
1. Governmental: includes federal, state, county, municipal, township, village, and other
local governmental units including special districts.
2. Educational: includes kindergarten, elementary and secondary schools, colleges and
universities.
3. Health and Welfare: includes hospitals, nursing homes, orphanages, Red Cross.
4. Religious: includes Churches, Salvation Army, Mosques and other religion related
organizations.
5. Charitable: includes Community chests, United Appeals, United funds, mother Teresa,
Mary Joy and other charitable organizations.
6. Foundations: private trusts and corporations organized for educational, religious or
charitable purposes.
1.2.2 Similarities & Differences: Governmental and NFP Entities
 Similarities

 Lack of competitive market place .Governmental and NFP entities operate in an

environment which is difficult to set the quality and quantity of service or
product

 Use of fund accounting as a control device both classes of organization are

organized and operated on fund basis
  Significant investment in non-revenue producing activities
 Differences

 Government differs from NFP entities in the following manners:

 Public corporations and bodies which are politic
 Power ultimately rests in the hands of the people – public officials are
accountable to the general public and the legislative, judicial, and executive
bodies will have an impact on their operation

 People can vote and delegate that power to public officials

 Government is created by and accountable to a higher level government
 Government has the power to tax citizens for revenue – taxpayers are the
providers of resources but the contribution may not be voluntary and the tax
payers have little say in deciding how to use the resources.

 The budget is an expression of public policy and method of providing control.

 The nature of the political process has a significant influence on their operation
 They may have monopoly power on some its services
 Criteria for Determining NFP Entity as Government
 An entity is said to be a government if one of the following conditions are met:

 Public corporations and bodies politic

 Popular election of officers, or appointment of a controlling majority of the
governing body by officials of another government

 Potential dissolution by a government with net assets reverting to a government

 Power to enact and enforce a tax levy
 Other NFP Organization differs from government with respect to the following
points:

 They are accountable to the resource providers (donors)

 The budget is an expression of the interest of the benefactors.
 The nature of the political system may not influence their operation
 The resource providers are donors, or volunteers and the contribution is mostly
 voluntary.
IPSAS further distinguishes governmental entities from not-for-profit entities and from
NFP entity by stressing that governments exist in an environment in which the power
ultimately rests in the hands of the people. Voters delegate that power to public officials
through the election process; the power is divided among the executive, legislative, and
judicial branches of the government so that the actions, financial and otherwise, of
governmental executives are constrained by legislative actions; and executive and
legislative actions are subject to judicial review. Further constraints are imposed on state
and local governments by the existence of the federal system in which higher levels of
government encourage or dictate activities of the lower levels and finance the activities.
1.2.3 Similarities and Differences: Business Entities and G & NFP
Entities
 Similarities of G and NFP Entities to Business Entities

 Both are integral part of an economic system

 Both acquire resources to provide goods or services
 Both use financial management processes
 Both need financial information systems
 Both undergoes cost analyses, control and evaluation techniques
 Both may provide similar services – e.g. transportation systems; sanitation
services; utilities, stadiums, arenas, etc.
 Differences between Businesses and G&NFP Entities
 Organizational objectives
 Operational focus
 Sources of Financial Resources
 Accounting and Financial Reporting
 Evaluation of Performance and Operating Results
 Regulation and Control
 Other Distinguishing Characteristics
1.3 Sources of Financial Reporting Standards for Governmental and
NFP Entities
The International Federation of Accountants /IFAC/ develops the International Public Sector
Accounting Standards /IPSASs. Currently the IPSASs are the only internationally
recognized set of public sector accounting standards. They are developed on the basis of the
International Financial Reporting Standards /IFRS/, which are generally applied in the real
economy.
The IPSAS aims:
  to improve financial management;
 to improve the quality of financial reporting;
 to increase the transparency and to achieve a higher credibility/reliability of financial
reports
International Public Sector Accounting Standards (IPSAS):
Accounting standards which establish guidelines on how economic transactions and events
should be reported in financial statements. Applied specifically for the public sector, but
largely based on International Financial Reporting Standards (IFRS).
Prepared and adopted by an independent board International Public Sector Accounting
Standard Board (IPSASB), part of the International Federation of Accountants (IFAC).

The development process of IPSAS

1.4 Objectives of Financial Reporting for NFP Entities

i. Objectives of Financial Reporting For Government
-The objectives of financial reporting by public sector entities are to provide information
about the entity that is useful to users of GPFRs for accountability purposes and for
decision-making purposes (hereafter referred to as “useful for accountability and
decision-making purposes”) -Financial reporting is not an end in itself. Its purpose is to
provide information useful to users of GPFRs. The objectives of financial reporting are
therefore determined by reference to the users of GPFRs, and their information needs.
Governmental financial reporting objectives are influenced by the characteristics of the
state and local governmental operating environment and by the needs of those who use
governmental financial reports. IPSAS Concept Statement No. 1 set forth the following
three financial reporting (FR) objectives:

A. Financial Reporting should assist users is assessing accountability by:

 Providing information to determine whether current-year revenues are
 sufficient to pay for current-year services ( Inter-period Equity)
 Demonstrating whether resources are obtained and used in accordance with
the entity's legally adopted budget, and demonstrating compliance with other
finance-related legal or contractual requirements
 Providing information to assist users in assessing the service efforts, costs,
and accomplishments of the governmental entity
ACCOUNTABILITY: is the cornerstone of all financial reporting in government.
Accountability arises from the citizens’ “right to know.” It imposes a duty on public
officials to be accountable to citizens for raising public monies and how they are
spent.
Inter-period equity relates to accountability. Government officials are accountable
and have an obligation to disclose whether current-year revenues were sufficient to
pay for current-year benefits or not. If inter-period equity is not achieved, the current
citizens are deferring payments to future taxpayers.
B. Financial Reporting should assist users in evaluating the operating results of the
governmental entity for the year by:
 Providing information about sources and uses of financial resources
 Providing information about how it financed its activities and met its cash
requirements
Providing information necessary to determine whether its financial position
improved or deteriorated as a result of the year's operations
C. Financial Reporting should assist users in assessing the level of services that can be
provided by the governmental entity and its ability to meet its obligations as they
become due by:
 Providing information about its financial position and condition.
 Providing information about its physical and other non-financial
resources.having useful lives that extend beyond the current year, including
information that can be used to assess the service potential of those resources
 Disclosing legal or contractual restrictions on resources and the risk of
potential loss of resources.
In general, financial reports are used in governmental entities primarily to:
 Compare actual financial results with legally adopted budget
 Assess financial condition and results of operations
 Assist in determining compliance with finance-related laws, rules, and
regulations
 Assist in evaluating efficiency and effectiveness
ii. Objectives of Financial Reporting for NFP Entities
NFP financial reporting should provide information useful in:
  Making resource allocation decisions
 Assessing services and ability to provide services
 Assessing management stewardship and performance
 Assessing economic resources, obligations, net resources, and changes in them
1.5 IPSAS versus IFRS
Key differences between IFRS and IPSAS
 IFRS is a financial reporting standard for profit motive business organization while IPSAS is
a financial reporting standard for public sectors.
• The differences in financial reporting requirements between the public and private sectors
are due largely to the environment in which the entities operate. Private sector entities will
tend to seek profit maximization and operate at arm’s length, whereas public sector entities
tend to focus on service delivery, often at below market terms.The public sector tends to
have many intra-governmental transactions, which are not always rooted in contracts. They
can also have different trigger points as to what may constitute a past event, such as
ministerial directions. These and other factors often mean that definition and scope need to
be tweaked for IFRS standards to work for public sector financial reporting.
 Borrowing costs: IFRS recognizes an asset for qualifying borrowing costs (IAS 23). IPSAS
allows choice, recognize borrowing costs incurred either as an expense or as an asset (see
IPSAS 5 Borrowing Costs)
 Heritage assets: IFRS recognizing and measuring heritage assets ( see IAS 16) .IPSAS
neither requires nor prohibits the recognition of heritage assets. The recognition and
measurement of heritage assets strictly optional (see IPSAS 17 Property, Plant and
Equipment) .
 Revenue from Non-Exchange Transactions: Unlike IFRS, IPSAS has an accounting
standard that explicitly covers revenue from non-exchange transactions (see IPSAS23
Revenue from Non-Exchange Transactions (Taxes and Transfers)).IPSAS23 defines non-
exchange transactions thus: “in a non-exchange transaction an entity receives value from
another entity without directly giving approximately equal value in exchange, or gives value
to another entity without directly receiving approximately equal value in exchange”.
 Asset impairment:Unlike IFRS, IPSAS provides specific guidance on how to determine the
value-in-use of non-cash-generating assets (see IPSAS 21 Impairment of Non-cash-
generating Assets). Value-in-use of non-cash-generating assetsis determined by using
depreciated replacement cost approach; restoration cost approach; or service units approach.

1.6 The Conceptual Framework for Public Sector Accounting [The

IPSASB]
The Conceptual Framework for General Purpose Financial Reporting by Public Sector
Entities (the Conceptual Framework) establishes the concepts that are to be applied in
developing International Public Sector Accounting Standards (IPSASs) and Recommended
Practice Guidelines (RPGs) applicable to the preparation and presentation of general
purpose financial reports (GPFRs) of public sector entities
The Conceptual Framework for General Purpose Financial Reporting by Public Sector
 Entities (the Conceptual Framework) establishes the concepts that underpin general
purpose financial reporting (financial reporting) by public sector entities that adopt
the accrual basis of accounting. The International Public Sector Accounting Standards
Board (IPSASB) will apply these concepts in developing International Public Sector
Accounting Standards (IPSASs) and Recommended Practice Guidelines (RPGs)
applicable to the preparation and presentation of general purpose financial reports
(GPFRs) of public sector entities.
The primary objective of most public sector entities is to deliver services to the
public, rather than to make profits and generate a return on equity to investors.
Consequently the performance of such entities can be only partially evaluated by
examination of financial position, financial performance and cash flows. GPFRs
provide information to users for accountability and decision-making purposes.
Therefore, users of the GPFRs of public sector entities need information to support
assessments of such matters as:
 Whether the entity provided its services to constituents in an efficient and effective
manner;
 The resources currently available for future expenditures and to what extent there
are restrictions or conditions attached to their use;
 To what extent the burden on future-year taxpayers of paying for current services
has changed; and
 Whether the entity’s ability to provide services has improved or deteriorated
compared with the previous year.
Types of financial report
Special Purpose Financial Reports:-responds to the requirements of users that have the
authority to require the reporting entity to provide the information that they need for
their purposes directly to them. Examples include: prudential regulation reporting
requirements tax reporting requirements Standard setters often describe as “special
purpose financial reports” those financial reports prepared to respond to the
requirements of users that have the authority to require the preparation of financial
reports that disclose the information they need for their particular purposes. The
IPSASB is aware that the requirements of IPSASs have been (and may continue to be)
applied effectively and usefully in the preparation of some special purpose financial
reports.
General Purpose Financial Reports;-General purpose financial reporting (GPFR)aims
to provide useful financial information about the reporting entity to primary users who
cannot require the reporting entity to provide information directly to them.
The Conceptual Framework acknowledges that, to respond to users’ information
needs, GPFRs may include information that enhances, complements, and supplements
the financial statements. Therefore, the Conceptual Framework reflects a scope for
financial reporting that is more comprehensive than that encompassed by financial
statements. Objectives and Users of General Purpose Financial Reporting, identifies
the objectives of financial reporting and the primary users of GPFRs. It also outlines
the consequences of the primary users’ likely information needs for what may be
encompassed within the scope of financial reporting.
Role of the Conceptual Framework
Conceptual Framework establishes the concepts that underpin general purpose
financial reporting (financial reporting) by public sector entities that adopt the accrual
basis of accounting. The International Public Sector Accounting Standards Board
(IPSASB) will apply these concepts in developing International Public Sector
Accounting Standards (IPSASs) and Recommended Practice Guidelines (RPGs)
applicable to the preparation and presentation of general purpose financial reports
(GPFRs) of public sector entities.
Authority of the Conceptual Framework
The Conceptual Framework does not establish authoritative requirements for financial
reporting by public sector entities that adopt IPSASs, nor does it override the
requirements of IPSASs or RPGs. Authoritative requirements relating to the
recognition, measurement and presentation of transactions and other events and
activities that are reported in GPFRs are specified in IPSASs.The Conceptual
Framework can provide guidance in dealing with financial reporting issues not dealt
with by IPSASs or RPGs.
In these circumstances, preparers and others can refer to and consider the applicability
of the definitions, recognition criteria, measurement principles, and other concepts
identified in the Conceptual Framework.
Applicability of the Conceptual Framework
The Conceptual Framework applies to financial reporting by public sector entities that
apply IPSASs.
Users of General-Purpose Financial Reports
Governments and other public sector entities raise resources from taxpayers, donors,
lenders and other resource providers for use in the provision of services to citizens and
other service recipients. These entities are accountable for their management and use
of resources to those that provide them with resources, and to those that depend on
them to use those resources to deliver necessary services. Those that provide the
resources and receive, or expect to receive, the services also require information as
input for decision-making purposes.
Consequently, GPFRs of public sector entities are developed primarily to respond to
the information needs of service recipients and resource providers who do not possess
the authority to require a public sector entity to disclose the information they need for
accountability and decision-making purposes. The legislature (or similar body) and
members of parliament (or a similar representative body) are also primary users of
GPFRs, and make extensive and ongoing use of GPFRs when acting in their capacity
as representatives of the interests of service recipients and resource
providers.Therefore, for the purposes of the Conceptual Framework, the primary users
of GPFRs are service recipients and their representatives and resource providers and
their representatives (hereafter referred to as “service recipients and resource
providers”, unless identified otherwise).
GPFRs prepared to respond to the information needs of the service recipient and
resource provider for accountability and decision making purpose and may also
provide information to other parties and for other purpose. E.g government
statisticians, analysts, the media, budget controller, entity management and others use
GPFR for their own purpose, they are not the primary user of GPFRs.
Qualitative characteristics: General purpose financial reporting
Fundamental qualities
 Relevance: capable of making a difference
 Faithful representation: complete, neutral and free from error
Enhancing qualities
o Understandability: GPFR presented clearly ,concisely and readily
understandable to any users.
o Timeliness: having relevant information available sooner
o Comparability: enable users to identify similarity in and difference between
two set of phenomena .
o Verifiability : consensus, but not necessarily complete agreement, that a
depiction is a faithful representation
If financial information is to be useful, it must be relevant and faithfully represent
what it purports to represent (i.e. fundamental qualities).
Financial information without both relevance and faithful representation is not useful,
and it cannot be made useful by being more comparable, verifiable, timely or
understandable.
Constraints on Information Included in General Purpose Financial Reports
 Materiality ; Information is material if its omission or misstatement could
influence the discharge of accountability by the entity.
 Cost-benefit; Financial reporting imposes costs. The benefits of financial
reporting should justify those costs.
 Balance between Qualitative characteristics; the qualitative characteristics
work together in different ways to contribute to the usefulness of information.
1.6.1 Fundamental Concepts Recognition, measurement, and
disclosure concepts
When to recognize assets and liabilities? the concepts
The item satisfies the definition of an element; and can be measured in a way that
achieves the qualitative characteristics and takes account of constraints of information
in GPFRs recognized as an asset and liability in the report.
Elements are the building block from which the financial statements are constructed
and in this context, elements are asset and liability defined in the following way. An
asset is a resource presently controlled by an entity as a result of past event and
provide future economic benefit.A liability is a present obligation of an entity for an
out flow of an resource result from past event.
However, in rare instances the level of uncertainty in a single point estimate is so large
that the relevance and faithful representativeness of the measure is questionable even if
disclosures are provided to explain estimation techniques. Under such circumstances
the item is not recognized.
The Measurement Basis
It refers to the concept that is used in determining the amount at which an asset or
liability is stated in the financial report.
The Objective of Measurement
The objective of measurement is:
To select those measurement basis that most fairly reflect the cost of services,
operational capacity and financial capacity of the entity in a manner that is useful in
holding the entity to account, and for decision-making purposes.The selection of a
measurement basis for assets and liabilities contributes to meeting the objectives of
financial reporting in the public sector by providing information that enables users to
assess:
 Cost of services – the cost of service provided in the period in historical or
current terms;
 Operational capacity- the capacity of the entity to support the provision of
services in future periods through physical and other resources; and
 Financial capacity - the capacity of the entity to fund its activities.
According to IPSAS there is no a single measurement basis for all circumstance.
An entity select the measurement basis, it achieve the objective of financial reporting
and qualitative characteristics of GPFR.
Measurement basis
 Historical cost
 Market values
 Replacement cost
Historical cost
Under the historical cost basis, assets are reported at the cost incurred on their
acquisition.Transaction costs that is, costs other than the purchase price incurred in
connection with the acquisition of the asset is generally included in cost for this
purpose.Like assets, liabilities are generally stated on the historical cost basis at the
amount received in the transaction under which the obligation is assumed.
Market Values
Under this measurement basis, assets and liabilities are stated at market prices
prevailing on the reporting date: it is therefore a current measurement basis.
Market value is amount for which a property should exchange on the date of the
valuation between a willing buyer and a willing seller in an arm’s length transaction.
Replacement Cost
The replacement cost of an asset may be defined as:The most economic cost required
for the entity to replace the service potential of an asset (including the amount that the
entity will receive from its disposal at the end of its useful life) at the reporting date.
Information Selected for Disclosure
Disclosed information is likely to include:
 The basis for the displayed information, such as applicable policies or
methodologies;
 Disaggregation of displayed information; and
 Items that share some but not all of the aspects of displayed information for
example disclosures on items that meet some, but not all, of the
characteristics of the definition of an element or disclosures on items that
meet the definition of an element, but not the recognition criterion.
Information disclosed in the notes to the financial statements:
◦ It is necessary to a user’s understanding of the financial statements;
◦ Provides information that presents the financial statements in the context of the
entity and its operating environment; and

◦ Generally will have a clear and demonstrable relationship to information

displayed on the face of the financial statement(s) to which it pertains.

◦ Entity-related factors that could influence judgments about reported

information (for example, information about related parties and controlled
entities or interests in other entities);

◦ The basis for what is displayed (for example, information on accounting

policies and measurement, including measurement methods and measurement
uncertainties where applicable).

◦ Disaggregation of amounts displayed on the face of the statements (for

example, a breakdown of property, plant and equipment into different classes);
 ◦ Information that may explain underlying trends affecting displayed totals.
◦ Items that do not meet the definition of an element or the recognition criteria,
but are important to an understanding of the entity’s finances and ability to
deliver services— for example, information about events and conditions, that
might affect future cash flows or service potential, including their natures,
possible effects on cash flows or service potential, probabilities of occurrence,
and sensitivities to changes in conditions

Chapter Two
Principles of Accounting and Financial Reporting of Governmental Entities
Chapter objectives
After completing this chapter, you should be able to:
 Explain the nature of the three major activity categories of a state or local
government governmental activities, business-type activities, and fiduciary
activities
 Discuss the basic accounting and Financial reporting principles for State and
Local Governments/SLGs/.
 Identify types of funds in each fund category and characteristics of each fund
type.
2.1 Activities of Government
There are three major activity categories of a state and local governments.
1. Governmental Activities,
2. Proprietary (Business-Type)Activities, and
3. Fiduciary Activities.
1. Governmental Activities;
This type of activities provide benefit to the whole of the society. Government
provides certain core services called General Activities.
These are:
 A Protection of life and property ,police and fire protection,
 A Public works (streets and highways, bridges, and public Building),
 A Cultural and social services
Governments also incur costs for general administrative support such as data
processing, finance, and personnel.The above two comprise the major part of
governmental type activities or simply Governmental Activities
2. Proprietary (Business-type) Activities
 Governments also engage in business type activities. These include:
 Public utilities (electric, Water, gas and sewer utilities)
 Parking garages and lots
 Transportations system;
 Swimming pool
 Toll roads and toll bridges;
 Stadiums and arenas
 Airports;
Many of these activities are intended to be self-supporting by charging users
for the services they receive. Operating subsidies from general revenues are
not uncommon, particularly for transportation systems.
3. Fiduciary Activities

 Governments often act in a fiduciary capacity, either asan agent or as trustee, for
parties outside the government.

 A government may serve as agent for other governments in the administering

and collecting of taxes.

 Governments serve also as trustees for amounts placed in trust from private
citizens for parks and other purposes, for escheat properties that revert to the
government when there are no legal claimants or heirs to a deceased
individual’s estate, and for assets being held for employee pension plans.
2.2 Summary Statement of Principles
Currently there are 13 accounting and financial reporting principles for state and local
Governments. They are principles of
1. Accounting and Reporting Capabilities
2. Fund Accounting Systems
3. Types of Funds
4. Number of Funds
5. Reporting Capital Assets
6. Valuation of Capital Assets
7. Depreciation of Capital Assets
8. Long-Term Liabilities
9. Measurement Focus and Basis of Accounting
10. Budgeting, Budgetary Control, and Budgetary Reporting
11. Transfer, Revenue, Expenditure, and Expense Account Classification
12. Common Terminology and Classification
13. Annual Financial Reports

Principle No. 1: Accounting and Reporting Capabilities

Governmental accounting system must make it possible both:
 To present fairly and with full disclosure the funds and activities of the government
in conformity with IPSAS ,and
 To determine and demonstrate compliance with finance related legal and contractual
provisions.
NOTE: if Government requires by law to follow practices different from IPSAS, they
may prepare two sets of financial statement. One in compliance with IPSAS , the other
in compliance with legal requirement.
Principle No 2: Fund Accounting System
Governmental accounting system should be organized and operated on fund basis. A
Fund is defined as a fiscal and accounting entity with a self-balancing set of accounts
reporting cash and other financial resources, together with all related liabilities and
residual equities or balances, and changes therein, which are segregated for the purpose
of carrying on specific activities or attaining certain objectives in accordance with
special regulations, restrictions or limitations.
Fiscal Entity refers to any entity that is concerned with some assets set aside for a
specific purpose, and Accounting Entity refers to anything that uses a double entry
accounting entity to balance the resources with claims to resources.

Fund and fund accounting is useful to:

 To control and segregate resources that are externally restricted and
internally (managerially) designated which have accountability
obligation.
 To ensure and demonstrate compliance with legal and administrative
requirements.

Principle No. 3: Types of Funds

SLGS, both general purpose and special purpose, should use 11 fund types as needed.These
fund types are organized into three categories;
i. Governmental funds,
ii. Proprietary funds, and
iii. .Fiduciary funds.
Funds should be used by state and local governments to the extent that they have activities
that meet the criteria for using those funds.
i. Governmental Funds:-
Account for activities of a government that are carried out primarily to provide
services to citizens and that are financed primarily through taxes.
Governmental Funds are classified into five:
 o General Fund,
o Special revenue funds,
o Capital projects funds,
o Debt service funds, and
o Permanent funds.
 The General Fund (GF) – account for all financial resources except
those required to be accounted for in another fund.
 It is used to account for resources required to provide most of the basic
services provided by the governmental unit such as public safety, public
works, education, etc.
 Only one GF is used per government and most financial transactions related
to general government operating activities are recorded in the GF
 Special Revenue Funds (SRFs) – to account for proceeds from specific
revenue sources (other than private purpose trusts or major capital
projects) that are legally restricted to use for specified purposes.
 The purpose of special revenue fund is to demonstrate that all revenues from that
source are used for the special purpose only.
 Example, a government earmarked 25% of current year revenue from value
added tax for draught affected people, special revenue fund may be
established to account for this revenue.

 Capital Project Funds (CPFs) – accounts for financial resources to be

used for the acquisition or construction of major capital project facilities
(other than those financed by proprietary funds or fiduciary funds).
 They are used to account for financial resources segregated to pay for
construction or acquisition of long-lived capital assets: The construction of
bridge, buildings, road, dams, railway, hydroelectric power etc.
 Debt Service Funds (DSFs) – are used to account for the accumulation of
resources for, and the payment of, general long-term debt principal and
interest.
Debt service funds does not account for a government’s long-term debt.
Rather, it monitors the financial resources currently available to satisfy long- term
liabilities and also records the eventual payments.
 Permanent Funds (PFs) – to account for legally restricted resources
provided by trust in which the earnings but not the principal may be used
for purposes that support the primary government’s programs (those that
benefit the government or its citizenry)
Note: similar permanent trusts that benefit private individuals, organizations, or other
governments that is, private purpose trust funds are classified as fiduciary funds).

ii. Proprietary Funds – account for a government’s ongoing organizations and

activities that are similar to those operated by for- profit organizations.
 This fund type normally encompasses operations where a user charge is
assessed so that determining operating income or cost-recovery is important.
 Two types of funds used by SLGS are classified as proprietary funds.
 Enterprise funds
 Internal Service funds
 Enterprise funds (EFS) - to account for operations
 That are financed and operated in a manner similar to private business enterprises–
where the intent of the governing body is that the costs (expenses) of providing
goods or services to the general public on a continuing basis be financed or
recovered primarily through user charges external to government; or
 Where the governing body have decided that periodic determination of revenues
earned, expenses incurred, and/or net income is appropriate for capital maintenance,
public policy, management control, accountability or other purposes.Examples of
activities that can be accounted through enterprise funds include water and other
utilities, airports, swimming pools and transit systems.
 According to IPSAS, a particular activity is accounted through enterprise fund if it
meets any one of the following criteria:
 Net revenues generated by the activity provide the sole security for the
debts of the security
 Laws or regulations require the activity’s costs to be recovered through
fees or charges
 Fees and charges are set at prices intended to recover costs including
depreciation and debt service.
 Internal Service Funds (ISFs) – to account for the financing of goods or
services provided by one department or agency to other departments or
agencies of the governmental unit, or to other governmental units, on a
cost reimbursement basis.
Like, enterprise funds, fees are charged but the service is performed for the primary
benefit of the government rather than for outside users. ISFs are usually reported as
governmental activities in the government-wide financial statements because they
primarily serve departments financed by governmental funds

iii. Fiduciary Funds – these are trust and agency funds that are used to account for
assets held by a governmental unit in a trustee capacity or as an agent for
 individuals, private organizations, and other governmental unit.
For these funds the government is acting as a collecting/disbursing agent or as a
trustee. There are four types of fiduciary funds:
 Pension Trust Funds - are used to report resources that are required to
be held in trust by the state for the members and beneficiaries of defined
benefit pension plans, defined contribution pension plans, and other
employee benefit plans.
 Investment Trust Funds - are used to report the external portion of the
Local Government Investment Pool, which is reported by the state as the
sponsoring government.
 Private-Purpose Trust Funds - are used to report trust arrangements,
other than pension and investment trusts, under which principal and
income benefit individuals, private organizations, or other governments.
The resources held under these arrangements are not available to support
the government’s own programs.
 Agency Funds - are used to account for resources held by the state in a
purely custodial/safeguarding capacity for other governments, private
organizations.
Principle No. 4: Number of funds

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 because unnecessary funds
result in inflexibility, undue complexity, and inefficient financial administration.
The fund types defined in the types of Funds Principle are to be used if needed by a
governmental unit to demonstrate compliance with legal requirements or if needed
to facilitate sound financial administration.
Principle No .5: Reporting Capital Asset
A clear distinction should be made between general capital assets and capital assets
of proprietary and fiduciary funds.
Capital assets of proprietary funds should be reported in both the government-wide
and fund statements.
Capital assets of fiduciary funds should be reported in only the statement of fiduciary
net assets.
All other capital assets of the governmental unit are general capital assets. They
should not be reported as assets in governmental funds but should be reported in the
Governmental Activities column in the government- wide statement of net assets.
Principle No .6: Valuation of Capital Asset

Capital assets should be reported at historical cost. The cost of a capital asset should include
capitalized interest (not applicable to general capital assets) and ancillary charges necessary
to place the asset into its intended location and condition for use.
Donated capital assets should be reported at their estimated fair value at the time of the
acquisition plus ancillary charges, if any.
Principle No .7: Depreciable of Capital Asset
Capital assets should be depreciated over their estimated useful lives unless they are either
inexhaustible or are infrastructure assets using the modified approach. Inexhaustible assets
such as land and land improvements should not be depreciated.
Depreciation expense should be reported in the government wide statement of activities;
the proprietary fund statement of revenues, expenses, and changes in fund net assets; and
the statement of changes in fiduciary net assets.
Principle No.8: Reporting Long Term Liability
A clear distinction should be made between other Liabilities and general Liabilities.
 Liabilities directly related to and expected to be paid from proprietary funds should
be reported in the proprietary fund statement of net assets and in the government-
wide statement of net assets.
 Liabilities directly related to and expected to be paid from fiduciary funds should be
reported in the statement of fiduciary net assets.
 All other unmatured general Liabilities of the government should not be reported in
governmental funds but should be reported in the Governmental Activity column in
the government-wide statement of net asset.
Principle No.9: Measurement Focus and Basis of Accounting the Basic Financial
Statement
A. Government-wide Financial Statements
 The government-wide statement of net assets and statement of activities
should be prepared using the economic resources measurement focus and the
accrual basis of accounting.
 Revenues, expenses, gains, losses, assets, and liabilities resulting from
exchange and exchange-like transactions should be recognized when the
exchange takes place.
 Revenues, expenses, assets, and liabilities resulting from non-exchange
transactions should be recognized in accordance “Non exchange
transactions.” Code
B. Fund Financial Statements
1. Financial statements for governmental funds should be presented using the
 current financial resources measurement focus and the modified accrual
basis of accounting.
 Revenues should be recognized in the accounting period in which they
become available and measurable.
 Expenditures should be recognized in the accounting period in which the
fund liability is incurred, if measurable, except for un matured interest on
general long-term liabilities, which should be recognized when due.

2. Proprietary fund statements of net assets and revenues, expenses, and

changes in fund net assets should be presented using the economic resources
measurement focus and the accrual basis of accounting.
3. Financial statements of fiduciary funds should be reported using the
economic resources measurement focus and the accrual basis of accounting,
except for the recognition of certain liabilities of defined benefit pension
plans and certain postemployment health care plans.
4. Transfers between funds should be reported in the accounting period in which
the inter fund receivable and payable arise.
Principle No .10: Budgeting, Budgetary Control and Budgetary Reporting
A. An annual budget(s) should be adopted by every governmental unit.
B. The accounting system should provide the basis for appropriate budgetary
control.
C. A common terminology and classification should be used consistently
throughout the budget, accounts, and financial statements.
 Budgetary comparison schedules should be presented for the General Fund and each
major special revenue fund that has a legally adopted budget as part of the required
supplementary information (RSI).
 Governments may elect to present the budgetary comparisons as part of the basic
financial statements.
Principle No. 11: Transfer, Revenue, Expenditure and Expense Account Classification
 Inter-fund transfers and proceeds of general long-term debt issues should be
classified separately from fund revenues and expenditures or expenses.
Classify revenues by fund and source.
 Governmental fund revenues should be classified by fund and source.
 Expenditures should be classified by fund, function (program), organization
unit, activity, character, and principal classes of objects.
 Proprietary fund revenues and expenses should be classified in essentially the
same manner as those of similar business organizations, functions, or
activities.
 CATEGORY OF REPORTING TREATMENT
INTERFUND
TRANSACTION
TYPES PAYEE (RECIPIENT) FUND PAYER FUND

Loans Liability Receivable

Interfund Services Revenue Expenditure / Expense

Reimbursements Reduce Expenditure / Expense Expenditure / Expense

Transfers Transfers In (“Other Financing Transfers Out (“Other Financing

Sources”) Uses”)

• Interfund loans:
– Loan between funds
– Expected to be repaid
– Impacts only the balance sheet
• Receivable in the lending fund
• Payable in the borrowing fund
– May charge interest
• Interfund services provided / used:
– Sales and purchases between funds
– Price should approximate external exchange value
– Similar to outside purchase (i.e., utilities)
– Revenue in the selling fund; expenditure or expense in the purchasing fund
– Record unpaid amounts as receivable or payable
• Interfund transfers:
– Nonreciprocal flow of assets among funds without an exchange or
expectation of repayment (i.e., cash or goods for operating or capital
purposes)
– or a flow of asset from one fund to another without a return of equivalent
asset or requirement for payment.
– Governmental fund reporting:
• Other financing sources (uses)
– Proprietary fund reporting:
• After non-operating revenues and expenses
• Interfund reimbursements:
 – Expenditures/expenses initially recorded in wrong fund
– or repayment to funds that are initially acquired a particular expenditure or
expense.
– Reimbursements not displayed in financial statements.
– Remove expenditure/expense from initial fund
– Record expenditure / expense in reimbursing fund
– No revenues reported, thus no double counting
• General long-term debt (GLTD) proceeds:
– Not recorded as fund liabilities
– Recorded as “Bond Issue Proceeds” in the “other financing sources” (not
revenue) section of governmental fund operating statement
– Record liability as a “general long-term liability”
(Not applicable to proprietary and fiduciary long-term debt)
Principle No. 12: Common Terminology and Classification
A common terminology and classification should be used consistently throughout
the budget, the accounts and the financial reports of each fund. Agreement on a
common terminology and classification scheme is needed to make sure that the
accounting procedures provide the information needed for budget preparation and
for financial statement and report preparation.
It is highly helpful to compare prior financial reports and current financial reports.
Principle No. 13: Annual Financial Reporting
Compressive Annual Financial Report (CAFR) should be prepared and published.
Comprehensive annual financial report (CAFR) recommended, including -
• Introductory section
• Management’s discussion and analysis (RSI)
• Basic financial statements (BFS)
• Other required supplementary information (RSI)
• Combining and individual fund statements
• Schedules
• Narrative explanations
• Statistical section
 Basic financial statements (BFS) are the minimum requirement
o Management’s discussion and analysis
o Basic financial statements
 Government-wide financial statements
 Fund financial statements – two types
- Individual fund statements and schedules
- Combining fund statements and schedules
  Notes to the financial statements
2.3 Summary Accounting Characteristics of Fund Types
2.3.1 Summary Accounting Characteristics Governmental Funds
 Focus on fiscal accountability
 Measure and report current(expendable)financial resources
 Use modified accrual basis of accounting
 Account for and report revenues and expenditures
 No capital assets or long-term liabilities accounted for in funds; no
depreciation reported in funds
 Budgetary accounts integrated in to the funds to achieve legal budgetary
control Required Financial Statements:
 Required Financial Statements:
 A Balance Sheet
 A Statement of revenues, expenditures, and changes in fund balances
 A Reconciliation of total fund balances of governmental funds to total
net assets of governmental activities at the government-wide level
 A Reconciliation of total changes in fund balances of governmental
funds to total changes in net assets of governmental activities at the
government-wide level
2.3.2 Summary Accounting Characteristics Proprietary Funds
 Focus on operational accountability
 Measure and report economic resources (a sin business accounting)
 Use full accrual basis of accounting
 Account for and report revenues and expenses
 Account for capital assets or long-term liabilities within the funds; report
depreciation
 Budgetary accounts not integrated in to the funds; should use budgeting
for planning and control
 Required Financial Statements:
◦ A Statement of net assets
◦ A Statement of revenues, expenses, and changes in net assets
◦ A Statement of cash flows
2.3.3 Common Accounting Characteristics Fiduciary Funds
◦ Accounting for fiduciary funds is similar to that for proprietary funds,
i.e., full accrual
◦ accounting and focus on flows of economic resources
◦ Capital assets and loitering or exceeding the budget typically carries
severe penalties for the administrator.
Budgeting and uses of budget
Budgeting is the process of creating a plan to spend your money .This-spending plan is
called a budget. Creating this spending plan allows you to determine in advance whether
you have enough money to do, the things you need to do or would like to do. If you do
not have enough money to do everything you would like to do, then you can use this
planning process to prioritize your spending and focus your money on the things that are
most important to you.
Usefulness of budget
1. Budget is used for planning, especially in clarifying priority goals, community
programs and service goals.
2. Budget is used as a way of controlling the assigned resources; ensuring that they
are used for the intended purpose.
3. Budget is used to provide information to decision-makers and indicate to the
public what decisions have been made about the objectives of the government.