FOCUS: FINANCE AND BUDGETING How to Read Governmental Financial Statements, Part 1 Gregory S. Allison anagement and elected to-actual financial statements (that officials of governmen- is, statements comparing budgeted Mtal entities receive an of- amounts with actual results); brief ten overwhelming supply of finan- analyses of tax billings and collec- cial data. This information takes tions, as well as general revenue various forms—budgetary re- collections; and investment sum- ports, internally generated finan- maries—these are a few examples cial statements, schedules and of the internal information that summaries, and audited annual should be available to manage- financial statements. Usually, in- ment and elected officials on a ternally generated information continuing basis. In most cases the comes in a format that is com- format of these presentations is left prehensible to accountants and to the discretion of management, nonaccountants alike. Compre- elected officials, and staff respon- hending the audited financial sible for preparing the informa- statements, however, requires at tion. Some governing bodies may least a minimal understanding of desire a summary of revenues by the principles of governmental category (property taxes, utility financial reporting. This article, billings and collections, other the first of two parts, is designed taxes, and so forth). Others may to make the audited financial focus on key ratios on a monthly statements more user-friendly and basis (for example, tax collection to provide a key to unlocking the rates and expenditures to date basic information they contain. compared with budget projec- The article focuses on current tions). reporting requirements. Part 2, Governments typically operate scheduled for a future issue of purely from a cash perspective: rev- Popular Government, will intro- enue is recognized when cash duce readers to new governmental is collected, and expenditures are financial reporting requirements that paring financial statements for external recognized as cash is disbursed. This is will be implemented over the next use. Thus the GAAP financial state- consistent with how they budget their three to five years. ments of a government in California operations. The balanced budget re- Governmental accounting and fi- may be compared with those of a gov- quirement in North Carolina presumes nancial reporting standards, referred to ernment in North Carolina. The consis- that all expenditures, or uses of finan- as generally accepted accounting prin- tency is invaluable to those outside the cial resources, will be funded either by ciples, or GAAP, are established by the government who rely on this informa- revenue sources (taxes, grants, utility Governmental Accounting Standards tion, primarily investors, creditors, and fees, and so forth) or by uncommitted Board. GAAP provide consistency in fi- bond rating agents, as well as to federal cash on hand (for example, available nancial reporting. In other words, they and state agency personnel. fund balance). Internal financial state- offer rules and formats for all govern- Management must have timely ac- ments most often stay consistent with ments in the country to follow in pre- cess to financial information in order to this type of reporting. However, exter- make decisions, evaluate compliance is- nal financial statements, such as the The author is an Institute of Government sues, and obtain an overall “feel” for an “official” financial statements prepared faculty member who specializes in govern- entity’s fiscal status. Reports prepared in conjunction with the annual audit, mental accounting and financial reporting. for internal use serve this need. Budget- are prepared with the intention of spring 2000, popular government 23 “providing a single financial report tai- Table 1. Fund Types lored to meet the basic information needs of a broad range of potential us- General fund Accounts for general operations of government (e.g., legislative, ers.”1 These audited financial state- administrative, public safety, sanitation, and recreation) ments are in a format that is useful for Special revenue fund Accounts for legally restricted revenue sources, those that must be those with an understanding of govern- used for particular activities (e.g., E-911 taxes and community development block grants) mental accounting—for example, ac- countants, investors, lenders, and rating Debt service fund Accounts for resources that governments are required to accumu- late to pay debt service in future years agents—and they provide an excellent summary of the fiscal year’s financial Capital projects fund Accounts for major capital activities or construction that is being financed by governmental resources (e.g., taxes) or by bonds that events. Ironically the preparation of will be repaid by governmental resources these GAAP financial statements is the Enterprise fund Accounts for activities that are usually supported by user fees (e.g., specific responsibility of management, water, wastewater, electricity, and natural gas services) but they often are confusing and of little Internal service fund Accounts for internal activities that provide service to other depart- practical use to management and elected ments (e.g., government motor pools, in-house print shops, and officials on a day-to-day basis. Never- warehousing for utility activities) theless, management and elected offi- Trust and agency funds Account for various activities for which government acts as cials can easily obtain useful informa- fiduciary (e.g., pension plans, execution of trust and bequest tion from these statements. agreements, and taxes collected on behalf of other governments) __________________________________________________________________________________________ Overview of GAAP Reporting of the financial statements themselves; The balance sheet is actually a “snap- Requirements see the sidebar, page 25). North Caro- shot” of the assets, the liabilities, and GAAP require that state and local gov- lina statutes require that all local gov- the equities—that is, the net worth—of ernmental entities use fund accounting, ernmental entities prepare these GAAP the fund types as of the end of the fiscal a concept unique to the government financial statements for the end of each year (June 30 for most North Carolina environment. Unlike agencies in the pri- fiscal year and have them audited by an governments, such as municipalities vate sector, governmental entities pro- independent certified public accoun- and counties). “Assets” is simply de- vide a tremendous variety of services. tant.2 These basic financial statements fined as items owned by the govern- Some services are “public purpose” in present aggregated information for ment (cash, investments, receivables, nature (for example, public safety, pub- each fund type. For example, a govern- fixed assets, and the like), and “liabili- lic works, and social services). Others ment may have three special revenue ties” is defined as obligations of the are “business-like” (for example, public funds, such as a community develop- government (for example, accounts utilities). The public-purpose services ment block grant fund, a capital reserve payable, salaries payable, and bonds are primarily financed by taxation fund, and an E-911 fund. For the basic payable). “Equity” is the net worth of (property taxes, sales taxes, income audited financial statements (often re- each of the fund types, which is simply taxes, and so forth), whereas most ferred to as the combined financial the fund’s assets minus its liabilities. business-like services are primarily fi- statements), that government combines This balance sheet is a visual represen- nanced by user fees (that is, payments these three special revenue funds into tation of the standard “accounting by those using the services). In most one column and identifies that column equation”: cases the various revenue sources for as the special revenue funds. Some ar- Assets = Liabilities + Equity the services each have restrictions on gue that this aggregation diminishes the how they may be used. Fund account- usefulness of the financial information. Each fund type is reported in a sepa- ing is an accounting and reporting ve- Most users of the information, how- rate column. Assets equal liabilities plus hicle that allows segregation of these ever, are assessing the government’s fi- equity for each column. services and their revenue sources. nancial situation as a whole. They do Unlike the operating statements, the Fund accounting uses three basic not necessarily need all the supporting balance sheet does not represent an ac- categories of funds: governmental, pro- detail. In contrast, internal reporting cumulation of transactions across the prietary, and fiduciary. Within each cat- almost always has a focus on the activi- year. Instead, it answers the following egory, several fund types are available ties of individual funds, which is neces- questions: to account for all the government’s ac- sary from an internal decision-making What does each fund type own as of tivities and services (see Table 1). perspective. • June 30? To present the minimum informa- • What does each fund type owe as of tion required by GAAP, governmental The Combined Balance Sheet— June 30? entities must prepare up to six basic fi- All Funds • What is each fund type’s net worth nancial statements and a comprehen- The combined balance sheet reports the as of June 30? sive set of related “note disclosures” assets, the liabilities,