new fun with FUND

BALANCES:ImpLEmENtINg gASB StAtEmENt 54

By Paul A. Copley CPA, Ph.D., and

M. Loretta Manktelow MBA, MST

12 Government Accounting • Disclosures • July/August

Government Accounting • Disclosures • July/August 13

Ten years ago, the Governmental Accounting Standards Board (GASB) issued Statement 34, which dramatically changed state and local government reporting by requiring accrual basis,

government-wide statements.For the first time since that noteworthy standard, GASB has issued a

new standard that is certain to affect the financial statements of every local government in Virginia. In the paragraphs that follow, we review GASB Statement 54, “Fund Balance Reporting and Governmental Fund Type Definitions,” which is required for fiscal years ending June 30, 2011.

The new standard is GASB’s response to credit market participants who sought greater information about the availability of reported fund balances. In particular, bond investors and rating agencies wish to under-stand the extent to which the financial resources of governmental funds are constrained and how binding those constraints are.

By Paul A. Copley CPA, Ph.D., and

M. Loretta Manktelow MBA, MST

For example, fund resources may be restricted by creditors, donors or granting agencies. Resources may also be formally committed by elected officials to specific activities. Alternatively, constraints may merely be nonbinding indications of manage-ment’s intent to use resources for a particular purpose. Statement 54 establishes new fund balance classifications to reflect these varying levels of constraint.

FUND BALANCE CLASSIFICAtIoNS

GASB Statement 54 establishes five new fund balance categories while eliminating the previous categories of reserved and un-reserved. The new standard affects only the equity section of the balance sheet of govern-mental funds. It does not change the report-ing of net assets of proprietary and fiduciary funds or the government-wide Statement of Net Assets.

The first step in applying Statement 54 is to identify those fund resources that are non-spendable. Inventories and prepaid items typically appear in governmental funds be-cause they are current assets. However, these resources are nonspendable because they are used in operations rather than converted into cash. The principal (corpus) of a permanent fund that is required to be maintained would also be classified as nonspendable.

The remaining resources (net of liabilities) of the fund include cash and items expected to be converted into cash in the next period. These “spendable” resources are further classified according to the nature of any

constraints imposed on their use, using a hi-erarchy of constraints. The hierarchy ranges from “restricted” for the most constrained to “unassigned” for the least.

Restricted fund balance represents the net resources of a governmental fund that are subject to constraints imposed by external parties or law. Restrictions arising from external parties include debt covenants (such as a requirement for a sinking fund) or constraints imposed by legislation or federal and state agencies on the use of intergov-ernmental revenues. Restrictions may also result from legally enforceable requirements that resources be used only for specific pur-poses.

For example, Virginia cities and counties may impose taxes on the sale of prepared food and beverages. If approved by the voters, the referendum commonly restricts the use of the tax proceeds (typically to capital projects). The (unexpended) resources derived from this tax would be displayed as restricted fund balance.

The equity section of the government-wide Statement of Net Assets in GASB 34 classifies net assets within three categories, including restricted net assets. With one excep-tion, those resources classified as restricted net assets in the government-wide statements would also be classified as restricted fund balance in the fund basis statements. The exception is permanent fund principal. These resources are classified as restricted net assets under GASB 34 and nonspendable fund bal-ance under GASB 54.

Committed fund balance represents the

net resources of a governmental fund that the governing body has specified for particular use. To be classified as committed, the re-sources should have been designated through ordinance or resolution by the government’s highest level of authority (e.g. city council or county board of supervisors). Commit-ted resources differ from restricted in that the constraint is imposed by a government upon itself.

Statement 54 also provides that amounts representing contractual obligations of a government should also be classified as com-mitted fund balance. The statement offers no examples of such contractual obligations, but it seems reasonable that they would be of sufficient significance to involve the formal action of the governing board. For example, board approval of large construction con-tracts would typically represent commitment of the funds.

Assigned fund balance represents the net resources of governmental funds that the government intends for a specific pur-pose. Assigned resources differ from com-mitted in that they do not require a for-mal action by the governing body. Con-straints imposed on assigned resources are more easily modified or removed. For governmental funds other than the Gen-eral Fund, this is the category for all (posi-tive) residual fund balances. The rationale is that the act of recording resources in special revenue, capital projects, debt service or permanent funds is evidence of the govern-ment’s intent to use the resources for a specific purpose. w

14 Government Accounting • Disclosures • July/August

Resources in the General Fund may also be assigned to a specific purpose if that is the intent of the government. Intent may be expressed through the governing body by means other than ordinance or resolution. Alternatively, committees or individuals may assign resources to specific activities. Assignment within the General Fund implies an intended use that is more limited than merely support of the gen-eral purposes of the government.

Unassigned fund balance is the residual category for the General Fund. Within the General Fund, governments should not report

assigned fund balance amounts if the assign-ment for specific purpose results in a negative unassigned fund balance.

NEgAtIvE BALANCESNegative fund balances could occur if ex-

penditures for a specific purpose exceed the resources available in the fund. However, Statement 54 does not permit the reporting of negative restricted, committed or assigned fund balances. If this occurs, the government should reduce any assigned fund balances (in that fund) by the amount of the negative balance.

The rationale is that if expenditures exceed restricted or committed resources, then funds have in effect been reallocated to the purpose used. If a deficit remains once all assigned fund balances are zero, the remaining nega-tive amount should be reported as unassigned fund balance.

ENCUmBrANCESUnder past reporting practices, outstanding

encumbrances at year-end were reported in the governmental funds as fund balance: reserve for encumbrances. Statement 54 requires that

Table 1: City Government Balance Sheet Governmental Funds as of June 30, 2011

General Fund

Special Revenue Fund

Capital Projects Fund

Debt Service Fund

Permanent Fund

Total Governmental Funds

ASSETS

Cash and cash equivalents $6,433,214 627,837 895,300 230,000 366 $8,186,717

Investments 3,287,992 25,000 3,312,992

Taxes receivable(net) 2,872,611 2,872,611

Accounts receivable 679,215 14,177 693,392

Due from State Government 1,085,184 243,264 1,328,448

Supplies Inventory 23,747 23,747

TOTAL ASSETS $14,381,963 642,014 1,138,564 230,000 25,366 $ 16,417,907

LIABILITIES

Accounts payable 2,628,422 70,000 226,532 2,924,954

Deferred Revenues 4,408,087 4,408,087

TOTAL LIABILITIES 7,036,509 70,000 226,532 - - 7,333,041

FUND BALANCE

Nonspendable

Supplies Inventory 23,747 23,747

Permanent fund principal 25,000 25,000

Restricted

Bond sinking fund 200,000 200,000

School lunch grant 370,000 370,000

School construction 302,000 302,000

Committed

City jail construction 120,000 120,000

Highway construction 450,000 450,000

Rainy day funds 3,000,000 3,000,000

Assigned

School lunch program 202,014 202,014

Capital additions 95,000 40,032 135,032

Debt Service 30,000 30,000

Other purposes 366 366

Library acquisitions 25,000 25,000

Unassigned 4,201,707 4,201,707

TOTAL FUND BALANCE $7,345,454 572,014 912,032 230,000 25,366 $9,084,866

Corpus of

permanent fund

Equals supplies

inventory

Restricted by debt

covenant, grant

agreement or law

Contractual

commitments

Committed by

City Council

Outstanding purchase orders of the General Fund

Residual balances of

funds other than the

General Fund

Residual balance of

the General Fund

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Government Accounting • Disclosures • July/August 15

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encumbered resources be reported within the restricted, committed or assigned categories in a manner consistent with the criteria for those classifications. Statement 54 provides no examples as guidance on how to classify encumbered amounts.

At the very least, the existence of an encum-brance suggests that the government has an ex-pressed intent to use resources for a particular purpose and therefore these resources should not be classified as unassigned. Encumbrance accounting may also be used in the case of contractual obligations, such as construction contracts. Statement 54 requires that resources obligated to contractual obligations be classified as committed.

StABILIzAtIoN (rAINy DAy) FUNDS

Statement 54 also provides guidance on the classification of budget stabilization or rainy day funds. Stabilization amounts that meet certain criteria are classified as committed or (less com-monly) restricted, if imposed externally or by law. Stabilization funds are classified as commit-ted if they are created by a resolution or ordi-nance that identifies the specific circumstances

under which the resources may be expended. Stabilization amounts that are available “in emergencies” or in periods of “revenue short-falls” would not be classified as committed unless the emergency or shortfall condition is speci-fied and of a magnitude to distinguish it from events that occur routinely. Stabilization funds not meeting these conditions are reported a s una s s i gned fund ba l ance i n t he General Fund.

SAmpLE BALANCE ShEEtTable 1 presents an example balance sheet

for a city government’s governmental funds using the fund balance classifications required by Statement 54. Note that fund balance (the shaded segment of the table) is no longer presented as reserved or unreserved and that encumbrances are not separately displayed. Explanations follow:

Nonspendable: The $23,747 in the General Fund equals the supplies balance reported within asset section of the balance sheet. Additionally, the city has a Permanent Fund in which the principal of $25,000 must be maintained.

Restricted: The Debt Service Fund reflects a sinking fund balance of $ 200,000 that is required by bond covenant. The city received a grant from the state government that is re-stricted for use in a school lunch program. The unexpended portion ($370,000) of this grant is reported in a Special Revenue Fund. The Capi-tal Projects Fund includes $302,000 of food and beverage tax revenues restricted by ballot referendum for new school construction.

Committed: The Capital Projects Fund includes amounts committed by contractual obligation with contractors building a new city jail ($120,000) and highway improve-ments ($450,000).Additionally, the General Fund reflects a rainy day fund ($3,000,000) established by city council resolution with specific circumstances under which the funds may be expended.

Assigned: The residual balances of the Special Revenue, Capital Projects, Debt Service and Permanent Funds are classified as assigned fund balance. Within the General Fund, outstand-ing encumbrances of $95,000 for capital w

16 Government Accounting • Disclosures • July/August

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additions and $25,000 for library acquisitions are classified as assigned fund balance, reflecting management’s intent to use the resources for a particular purpose.

Unassigned: The $4,201,707 residual balance of the General Fund is reported as unassigned fund balance.

FUND DEFINItIoNSStatement 54 also modifies the existing

governmental fund definitions to ensure con-sistency with the classifications of fund balances. For most of the funds, the revised definitions have little effect on current practice. The ex-ception is special revenue funds. Specifically, the standard requires that special revenue funds be used only if a substantial portion of the re-sources are provided by one or more restricted or committed (not assigned) revenue sources.

Although other resources may supplement a special revenue fund, assignment of resources is not sufficient for the establishment of one. Further, if the government expects that a substantial portion of the resources will no longer be derived from restricted and commit-ted revenue sources, the government should

discontinue the use of a special revenue fund and report the fund’s remaining resources in the General Fund.

CoNCLUSIoNThe fund balance reporting requirements

of GASB Statement 54 go into effect for fiscal years ending in June 2011. However, State-ment 54 requires governments to restate fund balances for all periods presented in a comparative balance sheet. Governments that present two years’ comparative balance sheets will effectively need to identify fund balance classifications as of June 2010.

In the coming year, CPAs may find client service opportunities by alerting local gov-ernment clients to the standard, identifying implementation issues ahead of time and sug-gesting actions that may ease the transition. For example, the differences between the fund balance classifications are based on degree of constraint. Since committed and assigned funds are both self-imposed, the distinction between these two categories is particularly ambiguous. To distinguish between these categories, gov-ernments will need to note the level of author-ity that approved the designation of resources

to a particular purpose.Some local governments may wish to report

rainy day reserves. These governments should verify whether the reserves were created by formal action of the board and whether the conditions under which the government may draw on these resources are sufficiently detailed and unusual to warrant classification as commit-ted fund balance.

Finally, governments should examine their existing governmental funds to ensure they meet the fund definitions provided by State-ment 54.The new standard is expected to limit the use of special revenue funds, and in some cases governments will be required to discontinue the use of special revenue funds and report those resources in the General Fund.

Paul A. Copley, CPA, Ph.D., and M.

Loretta Manktelow, MBA, MST, are on

the faculty of the School of Accounting

at James Madison University. Contact

Paul at copleypa@jmu.edu and Loretta at

mankteml@jmu.edu.