Chapter One

Financial Reporting for Governmental and Not-for-Profit Entities

Accounting and its Categories

What is accounting?
Accounting is the information system that provides essential information about financial
Activities of entity to various individuals or groups (users of accounting information) for their
use in making informed judgment and decision.

Accounting plays an important role in development of our economic and social system by
providing reliable accounting information to the various users.

Like medicine and law, accounting too has responded to its users by developing sub-fields or
areas of specialization, keeping growth in mind. These include:

Financial accounting, Management accounting, Cost accounting, Tax accounting …and Not-for-
profit accounting.

Not-for profit accounting-Is a field of accounting specialized in recording, reporting and

planning various operations of governmental units and other not for profit organizations (such as
churches, charities etc.).An essential element here is an accounting system that will ensure strict
adherence in on the part of management to restrictions and other requirements imposed by law,
by other institutions, or by individual donors.

Overview of Governmental and NFP organizations:

Organizations are generally classified into two major categories:

 Business or Commercial organizations

 Not-for-profit entities

Business organizations:

 Basic motive is to earn profit

 Its existence depends on the ability to generate profit
 Also known as profit organizations

Not-for-profit organizations:

 Basic motive is to give service to society and people

 Whose existence depends on the general public, Taxes collection from people and
donations received from the people.

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Entities or organizations that are established with operating purpose other than profit making
include:
 Governmental Entity (public sectors)
 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.

Examples of services provided by governmental organization:

Water, Electricity, Sanitation facilities, Public parks, Transportation, Communication,
Educational facilities, Medical and Health facilities, Police protection, Roads, Bridges and Dams
construction etc.

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 by Federal government, state governments, zonal governments, 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
Example
 Save the Children UK and Canada
 Family Guidance Association of Ethiopia
 Dawn of Hope Ethiopia
 Menschen for Menschen
 Rift Valley Children and Women Development Fund
 National Museum

Major Types of Governmental and Nonprofit Entities

 General Government – includes federal, state, county, city, town, village, special districts

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  Educational – includes kindergartens, primary and secondary schools, vocational &
technical schools, colleges, and universities
 Health and Welfare – Hospitals, Clinics and the Red Cross, etc
 Religious – churches, mosques, missions
 Charitable – includes many NGOs

Distinguishing Characteristics of Governmental and Business Organizations

Governmental and not-for-profit organizations differ in important ways from business

organizations. Not surprisingly, the accounting and financial reporting for governmental and not-
for-profit organizations are markedly different from accounting and financial reporting for
businesses. An understanding of how these organizations differ from business organizations is
essential to understand the unique accounting and financial reporting principles that have
evolved for governmental and not-for-profit organizations.
Specifically, the following are points that distinguish governmental organizations.
1. The profit motive is not inherent in their inception or operation
Governmental entities render services to the citizenry without the objectives of making a profit
from those services. However, there are some exceptions in which case public enterprises
generate profit from the services they render to the public.
2. Governmental organizations exist to serve the citizen
The basic philosophy of the government is to serve the citizen subject to its jurisdiction. This is
due to the fact that governmental entities are established by the citizen as a whole through the
constitution and charter process. However, business organizations are established by only few
individuals.
3. Taxation is the principal source of revenue to governmental organizations.
The citizens provide resources to the governmental entity through taxation. Tax is a compulsory
contribution made by the citizens to help the government expenditure in providing public goods.
This is subject to the jurisdiction of the government.

4. Impact of the legislative process.

For the most part, operations of the governmental entities are initiated by various legislative
enactments, such as operating budgets, borrowing authorizations, and tax levies. Although they
are affected by government laws and regulations, business organizations are not directly affected
by them.

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5. Governmental organizations provide stewardship services for resources.
A primary responsibility of governmental entities is to demonstrate adequate stewardship for
resources provided by the citizens.
6. Budget plays important role in governmental organizations
Budget is an instrument of allocating resources for the intended purposes, without which no
resources are allocated.
7. Absence of defined ownership interests that can be sold, transferred, or redeemed, or that
convey entitlement to a share of a residual distribution of resources in the event of liquidation of
the organization.
Similarities between Business Organizations and Governmental Organizations

Although there are differences between governmental and business organizations, they have
some points in common.
These are:
1. Both governmental and business organizations are integral part of the same economic
system.
2. Some of governmental and business organizations utilize similar resources in accomplishing
their purposes. For example, public health institutions and private institutions use medical
doctors, nurses, medical equipment, and the like.
3. Both governmental and business entities essentially use the same financial management
process. Financial management is concerned with the raising of financial resources and the
utilization of these resources efficiently and effectively.
4. In some cases, both produce similar products and/or services. The products or services of
some governmental and business organizations are similar. For example, if we compare one
public educational institutions and one private institution, the products of both are trained
manpower; similarly, private and public hospitals produce the same output-treated patient.
5. Both emphasize the utilization of resources economically, efficiently and effectively.
Efficiency refers to the degree to which organizational objectives have been met with
minimum amount of resources. Effectiveness refers to the degree to which organizational
objectives are met. Although it is not easy to measure efficiency in governmental units as
compared to business organizations, both strive for the efficient, economical and effective
utilization of resources.

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Differences between Business Accounting and Governmental Accounting

Differences between Governmental Accounting and Commercial Accounting

There are several differences between government accounting and commercial accounting.
These are summarized below:
1. Basis of Accounting
IFRS for commercial accounting require the use of accrual basis of accounting. But, in
governmental accounting, accrual or modified accrual basis of accounting, as appropriate, may
be used.
2. Accounting Entity
In commercial accounting, there is only one accounting entity within a given organization. But,
in government accounting there are more than one accounting entities called funds.
3. Impact of Legal Requirements
In commercial accounting, recording and reporting of transactions are not as such affected by
legal requirements. However, in government accounting, accounting and reporting of sections
are significantly influenced by legal requirements.
4. Objective of Accounting and Reporting
In commercial accounting, the focus is based on the determination of net income. As a result, the
objective of accounting is to ascertain the result of operation with the help of income statement
and also to ascertain the financial position at the end of the year with the help of balance sheet.
On the other hand, the focus of government accounting is primarily based on the flow of
financial resources i.e. the resources inflows, outflows, and their balance. The objective of
government accounting, therefore, is the financial administration of the activities of the
government to promote maximization of welfare in the form of various services.
5. The role of Budget
In government accounting, budget is the most important instrument of resources allocation. As a
result, it becomes a legal document and the accounting system incorporates the mechanism
through which it is recorded. Government budgets are expressions of public policy priorities and
legally authorize the purposes for which public resources may be spent. Government budgets are
the primary method by which citizens and their representatives hold the government's
management financially accountable. For this, budgetary accounts are included in the ledger.
But, in commercial accounting, budget is not considered as a legal document and is not formally

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recorded in the ledger. In other words, commercial accounting does not provide the basis for
budgetary control. The budget represents an internal financial management tool that is controlled
entirely by the management and is considered proprietary in nature.
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
Sources of Accounting and FR Standards for G & NFP Entities

The FASB establishes accounting and financial reporting standards for business (For-Profit)
organizations; the IPSASB establishes standards for governmental organizations. Authority to
establish accounting principles (accounting and financial reporting standards) for not-for-profit
organizations is split between the IPSASB and the FASB because a sizable number of not-for-
profit organizations (particularly colleges and universities, and hospitals) are governmentally
related, for which IPSASB establishes the standards and for Non-governmental NFP – IPSAS
establishes the standards.

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The following chart gives a clear picture about the accounting and reporting standards applicable
to: a) Business organizations
b) Governmental organizations
c) NFP organizations
Financial Accounting
Foundation
(FAF)

International Accounting International public sector

Standards Board (IASB) accounting standard
board(IPSASB

Business (For- Governmental -Profit Governmental Not- Non G.Vtal

Profit) Organizations for-Profit Not for profit
Organizations Organizations Organizations

Sources of Accounting and Financial Reporting Standards for G&NFP Organization

International Public Sector Accounting Standards (IPSASs) Vs International Financial Reporting

Standards (IFRS)
 International Public Sector Accounting Standards (IPSAS) is considered the definitive set of
accrual based international accounting standards for the public sector.
 There is a close relationship between IPSAS and International Financial Reporting Standards
(IFRS) due to the fact that IPSAS standards are largely based on the principles of IFRS.
 The rationale for drawing from IFRS is to ensure greater comparability between private and
public sector reporting when accounting for similar types of transactions.
 However, IFRSs are developed primarily for profit-oriented entities, whereas IPSASs are written
for public sector entities that provide services to enhance and maintain the well-being of the
citizens of a state.
 These differences between the two reporting frameworks stem primarily from the following three
sources: –
 Changes made by the IPSASB when developing an equivalent IPSAS based on an IFRS,
to reflect differences between the public and private sectors –
 Differences in the range of topics covered by the two sets of standards because of
differences in the prevalence of particular types of transactions, such as non-exchange
transactions
 Differences in the timing of when new or amended requirements are introduced into each
set of standards