Guide to Accrual Accounting for Ohio’s Rural Transit Systems March 2009 Prepared For The Ohio Department of Transportation (ODOT) Office of Transit Prepared By Table of Contents Page No. Section 1 – Why Accrual Accounting 1 Federal Transit Administration (FTA) Requirement 1 Ohio Department of Transportation (ODOT) Requirement 2 Cash vs. Accrual Accounting 3 Good Business Practice 6 Recap – Why the Accounting Method Matters 7 Section 2 – Basic Accounting Principles 8 Overview 8 Bookkeeping vs. Accounting 10 Accounting Equation (Assets = Liabilities + Owner’s Equity) 11 Revenue Recognition and Matching Principles 13 Chart of Accounts – Normal Balances 14 Debits and Credits 16 Accounting Cycle 18 o Record (Journalize) Transactions 18 o Post Journal Entries to Ledger Accounts 25 o Prepare a Trial Balance 28 o Make Adjusting Entries & Prepare Adjusted Trial Balance 29 o Prepare Financial Statements 32 o Journalize & Post Closing Entries & Prepare Closing Trial 40 Balance Section 3 – Ohio Rural Transit Systems & ODOT Quarterly 41 Invoice Report Revenue Transactions 41 o Transportation Revenues 41 o Non-Transportation Revenues 42 Expense Transactions 43 o Labor (Wages) 43 o Fringe Benefits 44 o Services 44 o Materials & Supplies 45 o Utilities 45 o Casualty & Liability Costs 46 o Taxes 46 o Purchased Transportation Services 46 o Miscellaneous Expenses 46 o Interest Expense 47 i o Leases & Rentals 47 o Depreciation 47 o Other Costs 47 Section 4 – Accrual Accounting Options 48 Manual Systems 48 Off-the-Shelf Software 48 Conversion of Cash Data to Accrual Format at End of Each 49 Quarter Professional Assistance 49 Section 5 – Exhibits & Samples 50 ODOT Chart of Accounts 50 Steps for Completing the ODOT Quarterly Invoice 50 Accrual Accounting - Class Exercise 58 ii Section One – Why Accrual Accounting Federal Transit Administration (FTA) Requirement For calendar year 2008 and beyond, the FTA began to require all transit systems (urban and rural) to report data using the accrual method of accounting. For rural systems this was a change because in the past they were permitted to report on a cash basis. This regulation issued in April of 2007 can be found in FTA Circular # C 9040.1F which states ―Costs incurred and available balances are reported annually on an accrual basis, on the Financial Status Report in FTA’s Transportation Electron Award Management (TEAM) System‖. -------------------- CIRCULAR U.S. Department of Transportation FTA C 9040.1F Federal Transit Administration April 1, 2007 Subject: NONURBANIZED AREA FORMULA PROGRAM GUIDANCE AND GRANT APPLICATION INSTRUCTIONS 1. PURPOSE. This circular is a re-issuance of guidance on the administration of the transit assistance program for nonurbanized areas under 49 U.S.C. 5311, and guidance for the preparation of grant applications. This revision incorporates provisions of the Safe, Accountable, Flexible, Efficient, Transportation Equity Act: A Legacy for Users (SAFETEA–LU), and includes the most up-to-date available guidance for the program. 2. CANCELLATION. This circular cancels Federal Transit Administration (FTA) Circular 9040.1E, ―Nonurbanized Area Formula Program Guidance and Grant Application Instructions,‖ dated October 1, 1998. ………. Chapter VI, financial Management 6.b (2) on page VI-7 (1) Costs incurred and available balances are reported annually on an accrual basis, on the Financial Status Report in FTA’s Transportation Electronic Award Management (TEAM) System. 1 Ohio Department of Transportation (ODOT) Requirement In Ohio, ODOT Office of Transit distributes federal funds to rural transit systems. ODOT is required to comply with all federal regulations associated with federal transit funds as well as ensure that all transit systems receiving federal funds are in compliance with applicable federal regulations. One such requirement is that rural transit systems report their financial data in an accrual accounting format to ODOT, who in turn must compile that data and provide reports to the FTA. ODOT is required to enforce this reporting requirement to assure compliance with FTA regulations. As a consequence, Ohio rural transit systems must now report their quarterly data to ODOT on an accrual basis . Accrual accounting reporting offers the advantage of allowing for more relevant statewide comparisons of system operations, and will assist ODOT in providing accurate and timely reports as requested from FTA, State legislators, other State departments, and other interested parties. During the fall of 2007, ODOT provided basic training on accrual accounting. This manual is intended to further assist Ohio rural transit systems in meeting the accrual accounting requirement by offering basic accounting information as well as specific accrual accounting applications and examples to assist in understanding and compliance. 2 Cash vs. Accrual Accounting Usually the first question on everyone’s mind is: Q: Can you explain the basic difference between cash and accrual accounting and tell me how it impacts the bottom line? A: Officially, there are two types of accounting methods, which dictate how a company's transactions are recorded in the company's financial books: cash- basis accounting and accrual accounting. The key difference between the two types is how and when they record financial transactions. Cash-basis accounting In cash-basis accounting, companies record expenses in financial accounts when the cash is actually laid out, and they book revenue when they actually hold the cash in their hands or, more likely, in a bank account. Accrual accounting If a company uses accrual accounting, it records revenue when the actual transaction is completed (such as the completion of work specified in a contract agreement between the company and its customer), not when it receives the cash. That is, the company records revenue when it earns it, even if the customer hasn't yet paid. Expenses are handled in the same way. The company records any expenses when they're incurred, even if it hasn't yet paid for the supplies or services. For example, when a transit system buys fuel for its buses they may very likely do so on account and not actually lay out the cash for the fuel until a month or so later when they get the bill. Under accrual accounting the fuel expense would be booked in the accounting period in which the fuel was used (this matches the expense with the service performed) not in a future period when the bill is actually paid. The next question is often: Q. Which method is better? A. For accounting and business planning purposes, the best method regardless of the type of business (except possibly a very, very, very, small business) is the accrual-based method. Cash-based accounting can distort the true operations of your business and incorrectly reflect income and expenses. Accrual accounting takes into account when something happens (not just when cash changed hands) and in today’s business world where most companies extend and receive 3 credit, the actual exchange of cash may take place months after the actual work was done, goods received, wages earned, etc. These are simple answers to more complex questions so lets look at the differences in more detail. Two Types of Financial Record Keeping – Cash & Accrual There are two types of accounting systems or methods available to business owners or non-profits to keep track of their financial records: cash accounting and accrual accounting. These two accounting methods are important to understand, because a business is required to use one or the other consistently in record-keeping for business and tax purposes. Here’s a definition of each: Cash Accounting In the cash accounting method, debits and credits are recorded to accounts only when money actually changes hands. For example, let’s assume a transit agency provides contracted service during December 2007, but doesn't get paid for the service until the following year, January 2008. In this simple example (if we assume that is the only transaction and the expenses associated with providing the service were paid in 2007), the agency reports a loss in 2007 because they paid for the wages, fringes, fuel and other expenses associated with providing the service in 2007. Conversely, the agency reports a huge profit in 2008 because they collected the revenue for the services previously provided and had no expenses (because all expenses were booked the prior year). Benefits of Cash Accounting 1. Working under a cash accounting model can be easier for small business owners in the sense of time spent. It is not much different that keeping a simple check book. 2. It’s often easier for small business owners to understand basic cash flow, as opposed to more complex asset and liability accounts. Drawbacks of Cash Accounting 1. The business or agency does not have a clear picture of who owes you money, or whom you owe money. 2. It makes it difficult, if not impossible, to easily evaluate a business’ financial success or failure. 4 Accrual Accounting In the accrual accounting method, debits and credits are recorded to accounts when the transaction itself takes place, regardless of when cash actually exchanges hands (with ―cash‖ meaning any kind of payment for goods or services rendered). The actual transaction actually consists of several parts: the transaction would first be accounted for in a receivables account (money owed to the company, as an asset); and the receivables account would be subsequently decreased when the cash account is increased once the payment was actually made (later in time). In our simple example used above, the transit agency would record contract revenue in December 2007, even though they have not as yet received payment. When the agency prepares their December financial statements, the expenses and the associated revenues are in the same time period as the service provided so a true picture of what they earned or lost that month exists. It can be said that the revenues match the expenses which is known as the ―matching principle‖ discussed later in this manual.