SEU The Hedging of A Net Investment in Foreign Subsidiaries Questions

Chapter 13
Governmental
Entities:
Special Funds and
Government-wide
Financial Statements
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
Understand and explain the
differences in financial
reporting requirements of
the different fund types.
13-2
Big Picture
 A government should establish those funds
required by law and the specific operating
and management needs of the government
entity.
 Figure 18-2 summarizes the different types
of funds.
13-3
Overview of Accounting and Financial Reporting for
Governments
13-4
The Governmental Funds:
General Fund (#1 of 5)
 General rule:
◼
◼
All activities should be accounted for in the
general fund unless specifically required by law
or
The nature of the activities is proprietary or
fiduciary.
 We discussed the general fund in chapter 17.
13-5
The Governmental Funds:
Special Revenue Funds (#2 of 5)
 Purpose: To account for the proceeds of specific
revenue sources that are legally restricted to
expenditure for specific purposes.
◼
◼
With the exception of inflows for Capital projects and
Expendable trusts.
Includes resources and expenditures for operations, such
as public libraries, when a separate tax is levied for their
support.
 Inflows: Usually from specific taxes or nontax
sources not directly related to services provided.
 A General Fund “clone”—identical accounting.
◼
Thus, we don’t discuss them in detail here.
13-6
Governmental Funds Worksheets
 Each of the five governmental funds will
report two fund-based financial statements:
◼
◼
The Balance Sheet
The Statement of Revenues, Expenditures, and
Changes in Fund Balance
13-7
Worksheet for the Balance Sheet for the
Governmental Funds
13-8
Worksheet for the Statement of Revenues, Expenditures, and Changes in
Fund Balances for the Governmental Funds
13-9
Practice Quiz Question #1
Which of the following statements is true
about fund accounting?
a. An enterprise fund is an example of
fiduciary fund.
b. Most transactions of a state or municipal
government are accounted for in the
general fund.
c. A capital projects fund is an example of
proprietary fund.
d. Most transactions of a state or municipal
government are accounted for in the
internal service fund.
13-10
Practice Quiz Question #1 Solution
Which of the following statements is true
about fund accounting?
a. An enterprise fund is an example of
fiduciary fund.
b. Most transactions of a state or municipal
government are accounted for in the
general fund.
c. A capital projects fund is an example of
proprietary fund.
d. Most transactions of a state or municipal
government are accounted for in the
internal service fund.
13-11
Learning Objective 2
Make calculations and
record journal entries for
capital projects funds.
13-12
The Governmental Funds:
Capital Projects Funds (#3 of 5)
 Purpose: To account for financial resources
used for the acquisition or construction of
major capital facilities
◼
Except for those financed by:
⚫
Proprietary Funds and
⚫
Trust Funds
13-13
The Governmental Funds:
Capital Projects Funds (#3 of 5)
 A temporary fund related to the acquisition
or construction of a specific capital project.
 At the completion of the project:
◼
◼
◼
◼
The fund is closed and
The project ’s cost is recorded as a capital asset
in the GCA-GLTL general ledger.
Outflows: Costs incurred during construction are
charged to expenditures.
Inflows: Bond sales and transfers from the
General Fund.
13-14
GCA-GLTL General Ledger
 Since governmental funds only report
current resources and obligations, the longterm assets and liabilities are recorded in
another location..
GCA = General Capital Assets
GLTL = General Long Term Liabilities
GCA-GLTL General Ledger
13-15
The Governmental Funds:
Capital Projects Funds (#3 of 5)
 Things to remember:
◼ Fixed assets or depreciation are not recorded in capital
projects funds
◼ Long-term debt is not recorded in capital projects funds
◼ Capital projects funds typically do not have operating
budgets
◼ A capital budget is prepared as a basis for selling bonds
to finance a project, and the capital budget is the control
mechanism for the length of the project
◼ The capital budget for the project may, or may not, be
formally recorded in the accounts
◼ The fund records capital outlays as expenditures
13-16
Practice Quiz Question #2
Which of the following statements is true
about capital projects funds?
a. Capital projects funds record depreciation.
b. Capital projects funds are permanent
because long-term assets remain in the
fund until disposal.
c. Capital projects funds are required by law
to have operating budgets.
d. When a capital project is completed, the
fund is closed and the asset is tranferred to
the GCA-GLTL general ledger.
13-17
Practice Quiz Question #2 Solution
Which of the following statements is true
about capital projects funds?
a. Capital projects funds record depreciation.
b. Capital projects funds are permanent
because long-term assets remain in the
fund until disposal.
c. Capital projects funds are required by law
to have operating budgets.
d. When a capital project is completed, the
fund is closed and the asset is tranferred to
the GCA-GLTL general ledger.
13-18
Learning Objective 3
Make calculations and record
journal entries for debt service
funds.
13-19
The Governmental Funds:
Debt Service Funds (#4 of 5)
 Purpose: To account for the servicing of debt
initially recorded as a liability in the GCA-GLTL
general ledger.
 “Servicing of Debt” is the payment of
◼
(1) interest and
◼
(2) debt principal at maturity.
 The accounting is the same as for the general fund.
 Unusual Features:
◼
◼
Interest is not accrued until the due date.
Principal payments are not recorded as liabilities until
the due date.
13-20
Debt Service Funds
 Examples of general long-term debt
obligations:
◼
◼
◼
◼
◼
Serial bonds
Term bonds
Special assessment bonds
Notes and warrants
Capital leases
13-21
Special Assessments
 Special Assessments are
◼
◼
Assessments made against taxpayers (citizens or
businesses) that directly benefit from
improvements.
Examples: sidewalks, street lighting, gutters
 Special Assessment Bonds are usually issued
to initially pay for the improvements.
◼
◼
Over time, the special assessments levied against
taxpayers are used to pay off the bonds.
All construction activity takes place in a Capital
Projects Fund.
13-22
The GCA-GLTL General Ledger
 Purpose of GCA-GLTL General Ledger:
◼
◼
Accounts for capital assets (at historical cost)
and
Long-term debt not accounted for in Enterprise
Funds, Internal Service Funds, or Trust Funds.
 The GCA-GLTL General Ledger is not a fund
◼
It has no cash for paying liabilities.
 It is a self-balancing set of accounts.
13-23
General Capital Assets
 Categories of Assets
◼
Land
◼
Buildings
◼
Improvements other than buildings
◼
Equipment
◼
◼
Construction work in progress (being performed
by Capital Projects Funds)
Infrastructure assets (see next slide)
13-24
General Capital Assets: Infrastructure Assets
 Capitalization is mandatory for public domain or
“infrastructure” capital assets such as:
◼
Streets and roads
◼
Sidewalks
◼
Bridges and tunnels
◼
Water and sewer systems
◼
Lighting systems
 Characteristics of infrastructure
◼
Stationary in nature
◼
Normally preserved longer than other capital assets.
13-25
General Capital Assets: Post-capitalization Periods
 Depreciation is mandatory—
except for certain infrastructure
assets:
◼
◼
Depreciation Expense is never
reported in the operating statement
of governmental funds.
It is reported only in the two
government-wide statements.
 Sales of Assets: record proceeds as
other financing sources in General
Fund.
13-26
General Long-term Liabilities
 Examples of Debt Recorded in GCA-GLTL
general ledger
◼
General obligation bonds (usually issued to
pay for capital projects).
◼
Claims and judgments.
◼
Compensated absences (vacation & sick pay).
◼
Unfunded pension contributions.
◼
Capital leases payable.
◼
Special assessment debt having government
commitment (explained earlier).
13-27
General Long-term Debt Liabilities
 Liquidation of GLTL
◼
◼
Debt Issuance Liabilities: at the maturity date,
the liability is transferred to a Debt Service Fund.
Nondebt Issuance Liabilities: at the payment
date, the liability is transferred to the General
Fund.
 Note that the GLTL is not removed from the
GCA-GLTL general ledger when it becomes a
current liability (due within 12 months).
13-28
Practice Quiz Question #3
Which of the following statements is true?
a. Long-term debt resides permanently in
the debt service fund.
b. The GCA-GLTL General Ledger services
interest payments on long-term debt.
c. Special assessments are levied against
the general population.
d. A debt service fund only makes interest
and principal payments.
e. Debt service funds accrue liabilities as
incurred.
13-29
Practice Quiz Question #3 Solution
Which of the following statements is true?
a. Long-term debt resides permanently in
the debt service fund.
b. The GCA-GLTL General Ledger services
interest payments on long-term debt.
c. Special assessments are levied against
the general population.
d. A debt service fund only makes interest
and principal payments.
e. Debt service funds accrue liabilities as
incurred.
13-30
Learning Objective 4
Make calculations and record
journal entries for permanent
funds.
13-31
The Governmental Funds:
Permanent Funds (#5 of 5)
 Permanent Funds:
◼
Are established when there is a donor restriction
requiring that
⚫
⚫
the fund principal be preserved and
the income from these permanent funds be used
to benefit the government’s programs or its
general citizenry.
 The accounting for permanent funds is similar
to that of the general fund.
13-32
Practice Quiz Question #4
Which of the following is NOT true about
permanent funds?
a. The principal of permanent funds is usually
required to be preserved.
b. The income from permanent funds is usually
allowed to be spent for the benefit of the
governmental entity and its citizens.
c. Permanent funds are accounted for in the
general fund.
d. The accounting for permanent funds is
similar to the accounting in the general fund.
e. Permanent funds usually have donor
restrictions.
13-33
Practice Quiz Question #4 Solution
Which of the following is NOT true about
permanent funds?
a. The principal of permanent funds is usually
required to be preserved.
b. The income from permanent funds is usually
allowed to be spent for the benefit of the
governmental entity and its citizens.
c. Permanent funds are accounted for in the
general fund.
d. The accounting for permanent funds is
similar to the accounting in the general fund.
e. Permanent funds usually have donor
restrictions.
13-34
Learning Objective 5
Understand and explain how
governmental funds are
reported and rules for separate
reporting as major funds.
13-35
Governmental Funds Financial Statements
 Required financial statements
1. The Governmental Funds Balance Sheet
2. The Governmental Statement of Revenues,
Expenditures, and Changes in Fund Balance.
 These statements are prepared for each
individual governmental fund
◼
These individual fund statements are the
foundation for the financial statements prepared
for the governmental entity.
13-36
Governmental Funds Financial Statements
 Major funds must be reported in separate columns
 GASB 34 specifies that the general fund is always a
major fund.
 Major funds: revenues, expenditures or expenses,
assets, or liabilities >=
◼
◼
10% of the total for their fund category or type
(governmental or enterprise) and
5% of the aggregate amount for all governmental and
enterprise funds
 Nonmajor funds are
◼
Aggregated and reported in a separate column (labeled
“other governmental funds”).
13-37
Practice Quiz Question #5
Which of the following is NOT true about
governmental reporting?
a. The special revenues fund is always a
major fund.
b. Non-major funds are aggregated and
reported in a single column.
c. The general fund is always a major fund.
d. Major funds are defined as those that
constitute at least 10% of their fund
category or 5% of all funds.
13-38
Practice Quiz Question #5 Solution
Which of the following is NOT true about
governmental reporting?
a. The special revenues fund is always a
major fund.
b. Non-major funds are aggregated and
reported in a single column.
c. The general fund is always a major fund.
d. Major funds are defined as those that
constitute at least 10% of their fund
category or 5% of all funds.
13-39
Learning Objective 6
Make calculations and record
journal entries for enterprise
funds.
13-40
The Proprietary Funds: Enterprise Funds
 Enterprise Funds account for activities
that provide services primarily to the public
◼
Examples: Gas, electric, water utilities
 Accounting like business accounting.
◼
◼
◼
Measurement focus on all economic
resources and the accrual basis of
accounting.
Report fixed assets, which are
depreciated, and long-term debt.
Focus on income determination and
capital maintenance.
13-41
Practice Quiz Question #6
Which of the following statements is true
about enterprise funds?
a. The activities accounted for in enterprise
funds primarily benefit other
government units.
b. The accounting for enterprise funds is
similar to the accounting for businesses.
c. Enterprise never report long-term
assets or depreciation.
d. A maintenance service center for public
busses other city vehicles is an example
of an activity accounted for in an
enterprise fund.
13-42
Practice Quiz Question #6 Solution
Which of the following statements is true
about enterprise funds?
a. The activities accounted for in enterprise
funds primarily benefit other
government units.
b. The accounting for enterprise funds is
similar to the accounting for businesses.
c. Enterprise never report long-term
assets or depreciation.
d. A maintenance service center for public
busses other city vehicles is an example
of an activity accounted for in an
enterprise fund.
13-43
Learning Objective 7
Understand and explain the
financial reporting of
proprietary funds.
13-44
The Financial Statements of Proprietary Funds
 Financial statements for the proprietary funds
◼
Can be major funds
⚫
⚫
If a governmental entity has more than one
enterprise fund, each must be individually
assessed
Must meet either the 10 percent criterion or the 5
percent criterion.
13-45
The Financial Statements of Proprietary Funds
 The financial statements for proprietary
funds are very similar to those for
commercial entities
1. The statement of net assets (balance sheet)
2. The statement of revenues, expenses, and
changes in fund net assets (income statement)
3. The statement of cash flows
 Budgeting in the proprietary funds also has
the same role as in commercial entities
13-46
The Financial Statements of Proprietary Funds
 Statement of net assets
◼
◼
Proprietary funds report their own fixed assets,
investments, and long-term liabilities
GASB 34 specifies that the net assets section be
separated into three components:
1. Invested in capital assets, net of related debt
2. Restricted because of restrictions beyond the
government’s control
3. Unrestricted
13-47
The Financial Statements of Proprietary Funds
 Statement of Revenues, Expenses, and
Changes
◼
A separation of operating and nonoperating
revenues and expenses is made to provide more
information value regarding the operations of
the proprietary funds.
13-48
The Financial Statements of Proprietary Funds
 Statement of Cash Flows
◼
Because of the large number of capital asset
acquisition and financing transactions, the GASB
specified four sections:
1. Cash flows from operating activities
2. Cash flows from noncapital financing activities
3. Cash flows from capital and related financing
activities
4. Cash flows from investing activities
13-49
Practice Quiz Question #7
Which of the following statements is true
about the financial reporting of proprietary
funds?
a. The financial statements are identical to
those of the general fund.
b. Proprietary funds do not need to meet
the 10% or 5% tests to be major funds .
c. Enterprise funds are always major funds.
d. Internal service funds are not required
to provide a statement of cash flows.
e. Proprietary funds provide financial
statements very similar to those of
commercial businesses.
13-50
Practice Quiz Question #7 Solution
Which of the following statements is true
about the financial reporting of
proprietary funds?
a. The financial statements are identical to
those of the general fund.
b. Proprietary funds do not need to meet
the 10% or 5% tests to be major funds .
c. Enterprise funds are always major
funds.
d. Internal service funds are not required
to provide a statement of cash flows.
e. Proprietary funds provide financial
statements very similar to those of
commercial businesses.
13-51
Learning Objective 8
Make calculations and record
journal entries for internal
service funds.
13-52
The Proprietary Funds: Internal Service Funds
 Purpose: to account for activities that
provide services solely to other departments.
 These services are not available to the
general public, making it different from the
enterprise fund.
 Accounting like business accounting.
◼
◼
Measurement focus on all economic resources
and the accrual basis of accounting.
Report fixed assets, which are depreciated, and
long-term debt.
13-53
Practice Quiz Question #8
Which of the following an example of an activity
that would be accounted for in an internal
service fund?
a. A public swimming pool.
b. A municipal golf course with a club house
used for weddings and other public
gatherings.
c. A maintenance department that provides
services to various government offices.
d. A state beach or park.
e. A city recreation center with weight rooms, a
workout facility, and a pool available to
citizens of the community.
13-54
Practice Quiz Question #8 Solution
Which of the following an example of an activity
that would be accounted for in an internal
service fund?
a. A public swimming pool.
b. A municipal golf course with a club house
used for weddings and other public
gatherings.
c. A maintenance department that provides
services to various government offices.
d. A state beach or park.
e. A city recreation center with weight rooms, a
workout facility, and a pool available to
citizens of the community.
13-55
Learning Objective 9
Make calculations and record
journal entries for trust funds.
13-56
The Fiduciary Funds
 Two categories (four types of funds)
◼
◼
Trust Funds
⚫
Pension (and other employee benefit) Trust Funds
⚫
Investment Trust Funds
⚫
Private-Purpose Trust Funds
Agency Funds
13-57
The Fiduciary Funds: Trust Funds
 Purpose: to account for the
investing and using of money in
accordance with stipulated
provisions of trust indenture
agreements or statutes.
◼
◼
◼
Pension (and other employee benefit)
Trust Funds
Investment Trust Funds (created by
GAS 31)
Private-Purpose Trust Funds
13-58
The Fiduciary Funds: Trust Funds
 Private-purpose Trust Funds account for
property held under trust arrangements which
benefit:
⚫
Individuals
⚫
Private organizations
⚫
Other governments
13-59
The Fiduciary Funds: Trust Funds
 Trust funds use the accrual basis of
accounting.
 Financial statements required:
◼
The statement of fiduciary net assets
⚫
◼
includes all trusts and agency funds
the statement of changes in fiduciary net assets.
⚫
includes only the trust funds because agency funds
do not have a net asset balance.
13-60
Practice Quiz Question #9
Which of the following is NOT true trust
funds?
a. Trust funds use the accrual basis of
accounting.
b. Trust funds can account for money that
belongs to employees.
c. Trust funds are not required to provide
financial statements.
d. Pension funds are an example of a trust
fund.
13-61
Practice Quiz Question #9 Solution
Which of the following is NOT true trust
funds?
a. Trust funds use the accrual basis of
accounting.
b. Trust funds can account for money that
belongs to employees.
c. Trust funds are not required to provide
financial statements.
d. Pension funds are an example of a trust
fund.
13-62
Learning Objective 10
Make calculations and record
journal entries for agency funds.
13-63
The Fiduciary Funds: Agency Funds
 Agency Funds serve as conduits for the
transfer of money.
◼
This role is purely custodial in nature.
 Since the assets belong to someone else,
assets always equal liabilities.
A = L
 The following items do not exist for agency
funds:
◼
A fund balance/equity
◼
An operating statement
13-64
The Fiduciary Funds: Agency Funds
 Agency funds account for resources held by a
governmental unit as a custodial agent for
◼
individuals,
◼
private organizations,
◼
other funds, or
◼
other governmental units.
 Agency funds use the accrual basis of
accounting.
 The financial statement for agency funds is
the statement of fiduciary net assets.
13-65
Practice Quiz Question #10
Which of the following is a good example of
an activity that would be accounted for in an
agency fund?
a. A public parking lot available to all citizens
that charges a fixed daily or monthly rate.
b. A county tax assessment agency that
collects property taxes for all cities in the
county.
c. A county owned ski resort that is available
to both county residents and nonresidents.
d. A public water utility providing services to
all residents of the county.
13-66
Practice Quiz Question #10 Solution
Which of the following is a good example of
an activity that would be accounted for in an
agency fund?
a. A public parking lot available to all citizens
that charges a fixed daily or monthly rate.
b. A county tax assessment agency that
collects property taxes for all cities in the
county.
c. A county owned ski resort that is available
to both county residents and nonresidents.
d. A public water utility providing services to
all residents of the county.
13-67
Learning Objective 11
Understand and explain the
preparation of government-wide
financial statements.
13-68
The Government Reporting Model
 GASB 34 specifies the reporting model
 What organizations comprise the
reporting entity?
◼
◼
◼
The primary government
A component unit for which the primary
government is financially accountable
Any organization that has a significant
relationship with the primary government
13-69
The Government Reporting Model
 What constitutes financial accountability?
◼
◼
Financial accountability is evidenced when the
primary government appoints a majority of the
organization’s governing board.
Financial accountability may also exist if the
organization has a separately elected or
appointed board but fiscally depends on the
primary government for the financial resources
required to operate.
13-70
The Government Reporting Model
 What other organizations should be
included in the reporting entity?
◼
◼
GASB 14 specifies a third category of
organizations to be evaluated to determine if
they are part of the reporting entity with the
primary government.
These are legally separate, tax-exempt entities
for which the primary government is not
financially accountable.
13-71
The Government Reporting Model
 How should the financial results of the
component units be reported?
◼
A choice between two methods:
⚫
⚫
Discrete presentation in a separate column of the
primary government’s financial statements
Blended presentation by combining the
organization’s results into the primary government’s
financial results
13-72
The Government Reporting Model
 The Comprehensive Annual Financial
Report (CAFR)
 The CAFR
◼
Government-wide statements (2)
◼
Fund-based statements (7)
13-73
The Government Reporting Model
 Two government-wide statements:
◼
The Statement of Net Assets
⚫
◼
includes all GCA and GLTL.
The Statement of Activities
⚫
includes depreciation expense.
 Presented on the accrual basis.
 Measure the flow of economic resources
◼
Like statements for a commercial enterprise.
 These two statements are presented in addition to
the 7 Fund-Based Financial Statements.
13-74
The Government Reporting Model
 The two government-wide statements must
distinguish between:
1. Governmental activities and
2. Business-type activities.
 The total primary government must be discretely
presented in addition to the component units
reported in separate columns.
 Fiduciary activities are excluded from the
government-wide statements if their resources are
not available to finance the government’s
programs.
13-75
The Government Reporting Model
 Important features of the government-wide
Statement of Net Assets:
◼
◼
◼
Reports all “general capital assets”—including
infrastructure.
Reports all debt—including GLTL.
Reports net assets in 3 categories:
1. Invested in capital assets, net of related debt
2. Restricted
3. Unrestricted
◼
In general, interfund balances (loans, advances,
and due to and due from accounts) are
eliminated.
13-76
The Comprehensive Annual Financial Report
13-77
Government-wide Statement of Net Assets
13-78
Government-wide Statement of Activities
13-79
Practice Quiz Question #11
Which of the following is NOT true about the
CAFR?
a. Government-wide financial statements are
similar to the balance sheet and income
statement disclosed by businesses.
b. Government-wide financial statements are
based on the modified accrual basis of
accounting.
c. Since governments provide the two
government-wide financial statements, they
are not required to provide fund statements.
d. Governmental reporting requires a
government-wide statement of cash flows.
13-80
Practice Quiz Question #11 Solution
Which of the following is NOT true about the
CAFR?
a. Government-wide financial statements are
similar to the balance sheet and income
statement disclosed by businesses.
b. Government-wide financial statements are
based on the modified accrual basis of
accounting.
c. Since governments provide the two
government-wide financial statements, they
are not required to provide fund statements.
d. Governmental reporting requires a
government-wide statement of cash flows.
13-81
Learning Objective 12
Understand and explain the
additional disclosures that
accompany government-wide
financial statements.
13-82
The Government Reporting Model
 Reconciliation schedules
◼
Required to reconcile the net change in the total
amounts reported on the governmental funds
statements with the amounts reported on the
government-wide statements
⚫
Reconciliation schedule for Statement of Net Assets
⚫
Reconciliation schedule for Statement of Activities
 Budgetary comparison schedule
◼
This should be presented as required supplementary
information for the general fund and for each special
revenue fund that has a legally adopted annual budget.
13-83
The Government Reporting Model
 Management’s Discussion and Analysis
◼
MD&A should be included in the required
supplementary information of the governmentwide financial statements to provide an
analytical overview of the government’s
financial and operating activities.
 Notes to the government-wide financial
statements
◼
GASB 34 specified a number of required note
disclosures.
13-84
The Government Reporting Model
 Interim reporting
◼
◼
Governmental entities generally are not required
to publish interim reports, although many
prepare monthly or quarterly reports
Internal management control instrument
 Auditing governmental entities
◼
Most entities are audited annually
◼
Different from the audit of a commercial entity
◼
Single Audit Act of 1984
13-85
Additional Considerations
 Special-purpose governmental entities
 Financial reporting for pensions and
OPEB plans
 Employer accounting for pensions and
OPEB plan benefits
 Accounting for termination benefits
13-86
Example
13-87
Practice Quiz Question #12
Which of the following is true about
required supplemental disclosures of
governmental entities?
a. Governments are autonomous and
need not provide any specific
disclosures.
b. The CAFR must include management
discussion and analysis.
c. No one reads governmental financial
reports, so it doesn’t really matter what
is disclosed.
d. Governments must provide quarterly
interim reports as part of the CAFR.
13-88
Practice Quiz Question #12 Solution
Which of the following is true about
required supplemental disclosures of
governmental entities?
a. Governments are autonomous and
need not provide any specific
disclosures.
b. The CAFR must include management
discussion and analysis.
c. No one reads governmental financial
reports, so it doesn’t really matter what
is disclosed.
d. Governments must provide quarterly
interim reports as part of the CAFR.
13-89
Conclusion
The End
Chapter 12
Governmental
Entities:
Introduction and
General Fund
Accounting
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
Understand and explain the
basic differences between
governmental and private
sector accounting.
12-2
Overview
 Governmental entities have operating
objectives different from those of commercial
entities.
 As a result, governmental accounting is
different from accounting for commercial
enterprises.
12-3
Overview
 Nature of governmental entities
1.
Collect resources and make expenditures to fulfil
societal needs
2.
Absence of profit motive except for some
activities
3.
Have legal authorization for their existence,
conduct revenue-raising through the power of
taxation, and have mandated expenditures they
must make to provide their services
4.
Control mechanism – Use of comprehensive
budgetary accounting
12-4
Overview
 Nature of governmental entities
5.
Accountability for the flow of financial resources
is a chief objective
6.
Typically are required to establish separate
funds to carry out various missions; each fund is
an independent accounting and fiscal entity
7.
Many fund entities do not record fixed assets or
long-term debt in their funds
8.
An important objective of governmental
financial reporting is accountability
12-5
History of Governmental Accounting
 History
◼
◼
◼
Before 1984, directed by the Municipal Finance
Officers Association (MFOA)
In 1934, the first statement on local
governmental accounting published
In 1968, Governmental Accounting, Auditing,
and Financial Reporting (GAAFR) was published
⚫
The GAAFR is periodically updated to include the
most recent governmental reporting standards
12-6
History of Governmental Accounting
 History
◼
◼
1974 –The American Institute of Certified Public
Accountants (AICPA) published an industry
audit guide, in which it stated that “except as
modified in this guide, they [GAAFR] constitute
generally accepted accounting principles”
March 1979 – The National Council on
Governmental Accounting (NCGA) issued its
Statement No. 1, “Governmental Accounting and
Financial Reporting Principles” (NCGA 1)
12-7
History of Governmental Accounting
 History
◼
◼
1984 – Governmental Accounting Standards
Board (GASB) established
GASB Statement No. 1
⚫
◼
The GASB stated that all NCGA statements and
interpretations issued and in effect on that date were
accepted as generally accepted accounting principles
for governmental accounting
GASB Statement No. 34
⚫
Established government-wide financial statements to
be prepared on the accrual basis of accounting and an
array of fund-based financial statements
12-8
History of Governmental Accounting
 History
◼
◼
The GASB continues to issue new standards to
meet the information needs of users of the
financial reports of governmental units.
Accounting for governmental entities is given
the general name of fund accounting.
12-9
The Governmental Accounting Standards Board
(GASB)
 GASB
◼
Created in 1984
◼
A sister organization to the FASB
◼
Establishes GAAP for state and local units
◼
◼
No authority to establish GAAP for the federal
government
Seven members—simple majority vote needed
(4 votes)
12-10
GAAFR: “The Blue Book”
 “Governmental Accounting, Auditing,
and Financial Reporting”
 Published by the Government
Finance Officers Association (GFOA).
 Neither prescribes nor
authoritatively interprets GAAP for
governmental units.
 Provides detailed guidance (many
examples) for applying
governmental GAAP.
 Widely used by governmental units.
12-11
Practice Quiz Question #1
Which of the following statements is correct?
a. The GASB is responsible to set standards
for governmental units and not-for-profit
entities.
b. The FASB was created in 1972 and sets
standards for governmental units.
c. The Blue Book contains financial
accounting standards for privately held
governmental agencies and companies.
d. The GASB is responsible for setting
standards for state and local governments
but not the federal government.
12-12
Practice Quiz Question #1 Solution
Which of the following statements is correct?
a. The GASB is responsible to set standards
for governmental units and not-for-profit
entities.
b. The FASB was created in 1972 and sets
standards for governmental units.
c. The Blue Book contains financial
accounting standards for privately held
governmental agencies and companies.
d. The GASB is responsible for setting
standards for state and local governments
but not the federal government.
12-13
Learning Objective 2
Understand and explain
major concepts of
governmental accounting.
12-14
Major Concepts of Governmental Accounting
 Elements of a Statement of Financial Condition
1.
Assets are resources with present service capacity that
the entity presently controls.
2.
Liabilities are present obligations to sacrifice resources
that the entity has little or no discretion to avoid.
3.
A deferred outflow of resources is a consumption of net
assets that is applicable to a future reporting period.
4.
A deferred inflow of resources is an acquisition of net
assets that is applicable to a future reporting period.
5.
Net position is the residual of all other elements
presented in a statement of financial condition.
12-15
Major Concepts of Governmental Accounting
 Elements of a the resource flows statements
1.
An outflow of resources is a consumption of net assets
that is applicable to the current reporting period
2.
An inflow of resources is an acquisition of net assets
that is applicable to the current reporting period
12-16
Major Concepts of Governmental Accounting
 Expendability of resources versus capital
maintenance objectives
Commercial Enterprises
Government Entities
Measurement focus
The flow of all economic
resources
Changes in current financial
resources available to
provide services to the
public in accordance with the
budget
Method of
accounting
Accrual method
Modified accrual method
Balance sheet
Contains both current and
noncurrent assets and
liabilities, and the change in
retained earnings reflects
the company’s ability to
maintain its capital
investment
Reports only current assets,
current liabilities, and a fund
balance
12-17
Practice Quiz Question #2
Which of the following statements is true?
a. Governmental units use the modified
accrual basis of accounting and focus on
the flow of all economic resources.
b. Commercial enterprises use the modified
accrual basis of accounting and focus on
the flow of all economic resources.
c. The balance sheets of governmental units
contain long-term assets and liabilities.
d. The balance sheets of commercial entities
contain a fund balance.
12-18
Practice Quiz Question #2 Solution
Which of the following statements is true?
a. Governmental units use the modified
accrual basis of accounting and focus on
the flow of all economic resources.
b. Commercial enterprises use the modified
accrual basis of accounting and focus on
the flow of all economic resources.
c. The balance sheets of governmental units
contain long-term assets and liabilities.
d. The balance sheets of commercial entities
contain a fund balance.
12-19
Learning Objective 3
Understand and explain the
differences between the
various governmental fund
types.
12-20
The Nature & Diversity of Governmental Activities
 The operations of governmental entities are
classified into three categories:
◼
◼
◼
Governmental—these activities do not
resemble commercial activities.
Proprietary—these activities resemble
commercial activities. Can measure profitability
or capital maintenance.
Fiduciary—holding and managing assets owned
by others (e.g., pension assets).
12-21
Use of Fund Accounting
 Fund Accounting
◼
◼
◼
◼
Accounting for certain activities separately from
all other operations.
Fund definition: A fiscal and accounting entity
with a self-balancing set of accounts (like a
branch or a division of a commercial entity).
The General Fund: The main and largest
fund—records most routine transactions.
The difference between a fund’s assets and
liabilities is called:
Government and
Fiduciary-type Funds
Fund Balance
Proprietary Funds
Net Assets
12-22
Major Concepts of Governmental Accounting
 Three Types of Funds
◼
Governmental Funds
⚫
⚫
◼
Proprietary Funds
⚫
◼
Used to provide basic governmental services to the
public
Each entity creates only one general fund, but it may
create more than one of each of the other types of
funds
The objective is to recover the unit’s costs through
user charges
Fiduciary Funds
12-23
Major Concepts : Types of Funds
 Governmental Funds
◼
◼
General Fund: Accounts for all activities not
required to be accounted for in another fund.
Special Revenue Fund: A clone of the General
Fund.
◼
Capital Projects Funds
◼
Debt Service Funds
◼
Permanent Funds
12-24
Major Concepts : Types of Funds
 Proprietary Funds
◼
Enterprise Funds:
⚫
⚫
◼
Provides services primarily to nongovernmental
users
Examples: City-owned utilities or recreational
facilities
Internal Service Funds:
⚫
Provides services solely to governmental
departments.
12-25
Major Concepts : Types of Funds
 Fiduciary Funds
◼
Trust Funds
⚫
Pension (and similar) Trust Funds
⚫
Investment Trust Funds
⚫
◼
Private-Purpose Trust Funds (these activities
do not benefit the government unit)
Agency Funds
12-26
Major Concepts of Governmental Accounting
Governmental Fund Types
General fund
Accounts for all financial resources except for those
accounted for in another fund. Includes transactions
for general governmental services provided by the
executive, legislative, and judicial operations of the
governmental entity.
Special revenue
fund
Accounts for the proceeds of specific revenue sources
that are restricted for specified purposes.
Capital projects
fund
Accounts for financial resources for the acquisition or
construction of major capital facilities that benefit
many citizens, such as parks and municipal buildings.
Accounts for the accumulation of resources for, and the
payment of, general long-term debt principal and
interest.
Debt service fund
Permanent fund
Accounts for resources that are restricted such that
only earnings, but not principal, may be used in support
of governmental programs that benefit the government
or its citizenry.
12-27
Major Concepts of Governmental Accounting
Proprietary Fund Types
Enterprise fund
Internal service fund
Accounts for operations of governmental units that
charge for services provided to the general public.
Accounts for the financing of goods or services provided
by one department or agency to other departments or
agencies of the governmental unit. Services are offered
only to governmental agencies.
Fiduciary Fund Types and Similar Component Units
Pension (and other
employee benefit)
trust fund
Investment trust fund
Private-purpose trust
fund
Agency fund
Accounts for resources required to be held in trust for
the members and beneficiaries of pension plans, other
post-employment benefit plans, or other EBPs.
Accounts for the external portion of investment pools
reported by the sponsoring government.
Accounts for all other trust arrangements under which
the fund’s resources are to be used to benefit specific
individuals, private organizations, or other
governments.
Accounts for assets held by a governmental unit in an
agency capacity for employees or for other
governmental units.
12-28
Practice Quiz Question #3
The three major categories of
governmental funds are:
a. Governmental, commercial, and
proprietary.
b. Governmental, trust, and fiduciary.
c. Enterprise, proprietary, and fiduciary .
d. Governmental, proprietary, and
fiduciary.
e. Governmental Service, proprietary,
and commercial
12-29
Practice Quiz Question #3 Solution
The three major categories of
governmental funds are:
a. Governmental, commercial, and
proprietary.
b. Governmental, trust, and fiduciary.
c. Enterprise, proprietary, and fiduciary .
d. Governmental, proprietary, and
fiduciary.
e. Governmental Service, proprietary,
and commercial
12-30
Learning Objective 4
Understand and explain basic
concepts for financial reporting
in governmental
accounting.
12-31
Financial Reporting of Governmental Entities
 Governmental funds – financial
statements
◼
◼
Balance sheet
Statement of revenues, expenditures and
changes in fund balance
 The five governmental funds use the current
financial resources measurement focus
12-32
Fund Accounting
 Specific General Ledger Accounts Used
defined by GASB 54:
Government and
Fiduciary-type
Funds
Fund Balance
Non-spendable
Spendable:
• Restricted
• Limited
• Assigned
• Unassigned
Proprietary Funds
Net Assets
Restricted
Unrestricted
12-33
Financial Reporting of Governmental Entities
Balance Sheet for Governmental Funds
Assets (financial resources available for current use;
presented in order of liquidity)
Total Assets
Liabilities and Fund Balances:
Liabilities (due and expected to be paid from current
financial resources; presented in order of due date)
Fund Balances
Nonspendable
Spendable:
Restricted
Limited
Assigned
Unassigned
Total Liabilities and Fund Balances
$X,XXX
$X,XXX
$ XXX
$ XX
XX
XX
XX
XX
XX
$X,XXX
12-34
Financial Reporting of Governmental Entities
 Statement of revenues, expenditures, and
changes in fund balance
◼
Often called the operating statement of the
governmental funds
Statement of Revenues, Expenditures, and Changes in Fund Balance
Revenues (recognized when both measurable and available; presented
by source of revenue)
$XX,XXX
Expenditures (approved decreases in net financial resources; presented
by function and character)
X,XXX
Excess of Revenues over Expenditures
$
XXX
Other Financing Sources or Uses (other increases or decreases in net
financial resources available, such as bond issue proceeds and interfund
transfers)
XX
Special Items and Extraordinary Items
(X)
Net Change in Fund Balance
$
XX
Fund Balance—Beginning
XXX
Fund Balance—Ending (reconciles to total fund balance on balance sheet) $
XXX
12-35
Practice Quiz Question #4
Which of the following is true?
a. The operating statements of governmental
entities focus on revenues and expenses.
b. The balance sheets of governmental entities
focus on the normal accounting equation:
Assets – Liabilities = Owner’s Equity.
c. The operating statements of governmental
entities focus on revenues and liabilities.
d. The balance sheets of governmental entities
focus a modified accounting equation:
Assets – Liabilities = Fund Balance.
e. All governmental fund balances are
spendable.
12-36
Practice Quiz Question #4 Solution
Which of the following is true?
a. The operating statements of governmental
entities focus on revenues and expenses.
b. The balance sheets of governmental entities
focus on the normal accounting equation:
Assets – Liabilities = Owner’s Equity.
c. The operating statements of governmental
entities focus on revenues and liabilities.
d. The balance sheets of governmental entities
focus a modified accounting equation:
Assets – Liabilities = Fund Balance.
e. All governmental fund balances are
spendable.
12-37
Learning Objective 5
Understand and explain the
basic differences in the
measurement focus and basis
of accounting between
governmental and private sector
accounting.
12-38
Measurement Focus And Basis Of Accounting
(MFBA)
 Measurement Focus
◼
What flows to measure for operations.
 Basis of Accounting
◼
When should transactions and events be recognized
in the financial statements.
12-39
MFBA: Governmental Activities
 Measure flow:
Current financial resources
◼
 Basis of Accounting:
Modified accrual basis of accounting
◼
•
Present a Statement of Revenues and
Expenditures and Changes in Fund Balance
– shows financial resources received and spent.
– shows change in net financial resources
available for spending in the near future.
12-40
MFBA: Current Financial Resources
 Current financial resources:
◼
Cash, property tax receivables, prepaids, and
supplies inventories.
 Claims against current financial resources:
◼
Wages, payroll taxes, payables to vendors, and
liabilities expected to be paid in the near future
(typically within 60 days after the year-end).
12-41
MFBA: Proprietary and Fiduciary Activities
 Measure flow:
◼
All economic resources
 Basis of Accounting:
◼
Accrual basis of accounting
• Present a Statement of Revenues and Expenses
– shows the change in the economic condition
• Also present a Statement of Cash Flows
12-42
Measurement Focus and Basis of Accounting
 The modified accrual basis is used in funds
that have a flow of current financial
resources measurement focus
◼
The five governmental funds have this focus
 The accrual basis is used in funds that have a
flow of economic resources measurement
focus
◼
Proprietary funds and fiduciary funds have this
focus
 The government-wide financial statements
are based on the accrual basis
12-43
Measurement Focus and Basis of Accounting
 Modified Accrual Basis Funds
◼
Governmental funds
⚫ General Fund
⚫ Special Revenues Fund
⚫ Capital Projects Funds
⚫ Debt Service Funds
⚫ Permanent Funds
12-44
Measurement Focus and Basis of Accounting
 Accrual Basis Funds
◼
◼
Proprietary funds
⚫
Enterprise Funds
⚫
Internal Service Funds
Fiduciary funds (3 Trust & 1 Agency)
 The two propriety funds and the three trust
funds have either a profitability or capital
maintenance orientation.
12-45
Measurement Focus and Basis of Accounting
 Modified Accrual Basis
◼
Revenues: Recognize in period in which they
become available and measurable.
⚫
◼
Available means: Collectible within the current
period or soon enough thereafter to be used to pay
current period liabilities.
Expenditures: Recognize in the accounting
period in which the liabilities are both
measurable and incurred and are payable out of
current financial resources.
⚫
One exception exists for interest on general longterm liabilities.
12-46
Measurement Focus and Basis of Accounting
 Recognition of revenue: how revenues are recognized
depends on the category
1.
Derived tax revenues, resulting from assessments on exchange
transactions
⚫
⚫
2.
The asset is recognized when the underlying transaction occurs or
resources are received, whichever comes first.
Revenue recognition depends on the accounting basis used to measure
the transaction.
Imposed nonexchange revenues, resulting from assessments on
nongovernmental entities, including individuals
⚫
⚫
The asset is recognized when the government has an enforceable legal
claim to the resources or the resources are received, whichever comes
first.
Revenue recognition is made in the period when use of the resources
for current expenditures is first permitted or required, or at the time
the asset is recorded if no time restriction on the fund’s use of the
resources exists.
12-47
Measurement Focus and Basis of Accounting
 Recognition of revenue: how revenues are recognized
depends on the category
3.
Imposed nonexchange revenues, resulting from assessments on
nongovernmental entities, including individuals
⚫
⚫
4.
5.
The asset is recognized when the government has an enforceable legal
claim to the resources or the resources are received, whichever comes
first.
Revenue recognition is made in the period when use of the resources
for current expenditures is first permitted or required, or at the time
the asset is recorded if no time restriction on the fund’s use of the
resources exists.
Government-mandated nonexchange transactions, resulting from
one governmental unit’s provision of resources to a governmental
unit at another level and the requirement that the recipient use the
resources for a specific purpose
Voluntary nonexchange transactions, resulting from legislative or
contractual agreements, other than exchanges
12-48
Practice Quiz Question #4
The modified accrual basis of accounting:
a. recognizes revenues when earned and
expenditures when incurred.
b. recognizes revenues when they become
available and measureable and expenditures
when liabilities become measurable and
incurred.
c. recognizes revenues when earned and
expenses when incurred
d. recognizes revenues when they become
available and measureable and expenditures
when they become available and spendable.
12-49
Practice Quiz Question #4 Solution
The modified accrual basis of accounting:
a. recognizes revenues when earned and
expenditures when incurred.
b. recognizes revenues when they become
available and measureable and expenditures
when liabilities become measurable and
incurred.
c. recognizes revenues when earned and
expenses when incurred
d. recognizes revenues when they become
available and measureable and expenditures
when they become available and spendable.
12-50
Learning Objective 6
Understand and explain basic
budgeting concepts in
governmental accounting.
12-51
Budgetary Aspects of Governmental Operations
 Budgets
◼
◼
Used in governmental accounting to assist in
management control and to provide the legal
authority to levy taxes, collect revenue, and
make expenditures in accordance with the
budget
Types of budgets:
⚫
Operating budgets
⚫
Capital budgets
12-52
Budgetary Aspects of Governmental Operations
 Appropriation: The statutory authorization for spending a
budgeted amount during a coming year.
 Annual Budgets for the General Fund and the Special
Revenue Funds are always recorded in the general ledger
for control purposes.
◼
Also done for Capital Projects Funds and Debt Service Funds if
useful.
 Encumbrances: Commitments related to unperformed
(executory) contracts for goods or services.
 Special general ledger accounts are used to record
encumbrances—the purpose is to prevent spending more
than has been appropriated.
 Budget entries have no effect on reported operations.
12-53
Introduction: Budget / Expenditure Process
1. Budget—Recorded in the books
◼
CAPITAL LETTERS (legally binding)
2. Expenditures
◼
◼
Appropriation (authorization of the expenditure)
Encumbrance (set aside or reserve part of the
budgetary appropriation)
◼
Expenditure
◼
Disbursement
12-54
Budgetary Aspects of Governmental Operations
 Recording the Operating Budget
Assume that at January 1, 20X1, the first day of the new fiscal period,
the city council of Barb City approves the operating budget for the
general fund, providing for $900,000 in revenue and $850,000 in
expenditures. Approval of the budget provides the legal authority to
levy the local property taxes and to appropriate resources for the
expenditures. The entry made in the general fund’s accounting records
on this date is as follows:
January 1, 20X1
(1) ESTIMATED REVENUES CONTROL
APPROPRIATIONS CONTROL
BUDGETARY FUND BALANCE—UNASSIGNED
900,000
850,000
50,000
Record general fund budget for year.
12-55
Budgetary Aspects of Governmental Operations
 The ESTIMATED REVENUES CONTROL account is an
anticipatory asset.
 The APPROPRIATIONS CONTROL account is an
anticipatory liability.
 The excess of estimated revenues over anticipated
expenditures is the budget surplus and is recorded to
BUDGETARY FUND BALANCE—UNASSIGNED.
 Some approved budgets have budget deficits in which
expected expenditures exceed anticipated revenue.
◼
These budgets are recorded with a debit to BUDGETARY
FUND BALANCE—UNASSIGNED.
12-56
Example: Budget / Expenditure Process
Assume a municipality approves the following budged:
◼ $900,000 in Revenues
◼ $850,000 in Appropriations
An appropriation of $15,000 is approved, but the final voucher
is paid for only $14,000.
12-57
Example: Budget / Expenditure Process
1. Budget
ESTIMATED REVENUES CONTROL
APPROPRIATIONS CONTROL
BUDGETARY FUND BALANCE—UNASSIGNED
900,000
850,000
50,000
2. Expenditures
◼
Appropriation
⚫
⚫
◼
Authorization of the expenditure (Annual Budget)
Person with authority (each expenditure authorized)
Encumbrance
ENCUMBRANCES
BUDGETARY FUND BALANCE—ASSIGNED FOR ENC.
15,000
15,000
12-58
Example: Budget / Expenditure Process
2. Expenditures
◼
Expenditure
BUDGETARY FUND BALANCE—ASSIGNED FOR ENC.
15,000
ENCUMBRANCES
◼
15,000
Disbursement
Expenditures
14,000
Vouchers Payable
Vouchers Payable
Cash
14,000
14,000
14,000
12-59
Text Page 837
12-60
Practice Quiz Question #4
Why to state and local governments record
encumbrances?
a. To ensure that the entity earns sufficient
revenues to achieve profitability.
b. To ensure that the entity does not spend more
than has been appropriated.
c. To ensure that all sub-entities within the
organization are not encumbered.
d. To ensure that the entity spends at least as
much as has been appropriated.
12-61
Practice Quiz Question #4 Solution
Why to state and local governments record
encumbrances?
a. To ensure that the entity earns sufficient
revenues to achieve profitability.
b. To ensure that the entity does not spend more
than has been appropriated.
c. To ensure that all sub-entities within the
organization are not encumbered.
d. To ensure that the entity spends at least as
much as has been appropriated.
12-62
Learning Objective 7
Make calculations and record
journal entries for the general
fund.
12-63
Accounting for Expenditures
 The Expenditure Process
◼
Step 1. Appropriation
⚫
◼
Step 2. Encumbrance
⚫
◼
An encumbrance is a reservation of part of the budgetary
appropriation and is recognized at the time an order is placed
for goods or services.
Step 3. Expenditure
⚫
◼
The budget provides the appropriating authority to make future
expenditures.
An expenditure and a corresponding liability are recorded when
the governmental entity receives the goods or services ordered
in Step 2.
Step 4. Disbursement
⚫
A disbursement is the payment of cash for expenditures.
12-64
Comparison of Accounting for Lapsing and
Nonlapsing Encumbrances at Year-End
12-65
Two Ways to Account for Supplies Inventories
 Consumption Method
◼
◼
◼
The preferred method—it parallels business practice.
The acquisition of inventory is treated as the conversion
of resources (debit Inventory).
The use of inventory is treated as an outflow of
resources (credit Inventory and debit Expenditures or
Expenses).
 Purchases Method
◼
The acquisition of inventory is treated as an outflow of
resources (debit Expenditures or Expenses).
12-66
Two Ways to Account for Supplies Inventories
 The specific method to follow depends on the governing
unit’s policy and how inventory expenditures are included
in the budget.
 Immaterial inventories need not be shown on the balance
sheet
 If the inventory is material, it is presented as an asset on the
balance sheet.
◼
An amount equal to the inventory also should be shown as a
reservation of the fund balance, indicating that that amount is
no longer expendable.
12-67
Accounting for Expenditures
12-68
Accounting for Expenditures
 Accounting for fixed assets
◼
◼
Governmental funds: Recognized as an expenditure in
the year the asset is acquired
Proprietary funds: Account for acquisitions of capital
assets in the same manner as commercial entities
 Works of art and historical treasures
◼
For the purposes of government-wide financial
statements, governments should capitalize these assets
at their historical costs at acquisition or at their fair
values at the date of the contribution
12-69
Accounting for Expenditures
 Long-term debt and capital leases
◼
◼
◼
◼
The governmental funds record the proceeds from a
bond issue as a debit to Cash and a credit to Bond Issue
Proceeds, an other-financing source.
Bond issue proceeds are not revenue because the bonds
must be repaid.
Bonds are not reported on the governmental funds’
balance sheets but only on the government-wide
financial statements.
Capital leases are accounted for in a manner similar to
long-term debt.
12-70
Accounting for Expenditures
 Investments
◼
◼
◼
GASB 31 established a general rule of fair market
valuation for investments held by a government entity.
Changes in the fair value of investments should be
recognized as an element of investment income in the
operating statement (or statement of activities) of each
fund.
GASB 40 requires footnote disclosures of the policies
and the profiles of the government’s investment
portfolios.
12-71
Group Exercise:
Comprehensive General Fund Entries
The City of Cottersen, Texas is a small town with a population of
approximately 15,000. The city noted the following transactions
during fiscal 20X8.
REQUIRED
1. Prepare General Fund journal entries only for these items.
2. Prepare closing entries at 6/30/X8.
3. Prepare a Statement of Revenues, Expenditures, and
Changes in Fund Balance as of 6/30/X8.
4. Provide a summary of the fund balance by category as of
6/30/X8.
12-72
Group Exercise:
Requirement 1 (Journal Entries)
1. The Cottersen city council approved the following budget:
Estimated revenues
$820,000
Authorized expenditures (including
$65,000 reappropriated for encumbrances
outstanding at 6/30/X7 that had lapsed)
720,000
Authorized transfers out to other funds
($35,000 and $20,000)
55,000
Estimated inflow from the discontinuance of
the Auto Repair Internal Service Fund
25,000
ESTIMATED REVENUES CONTROL
820,000
ESTIMATED TRANSFER IN
25,000
APPROPRIATIONS CONTROL
APPROPRIATIONS—TRANSFER OUT
BUDGETARY FUND BALANCE—UNASSIGNED
To record the budget.
720,000
55,000
70,000
12-73
Group Exercise:
Requirement 1 (Journal Entries)
2. The city levied property taxes totaling $570,000. Of this
amount, $10,000 was estimated to be uncollectible.
Collections during the year totaled $525,000, of which
$12,000 were associated with property taxes levied in the
prior year that had been declared delinquent at the end of the
prior year. All of the remaining property taxes receivable at
the beginning of the current year, totaling $5,000, were
written off as uncollectible. The net realizable amount at
6/30/X8 ($11,000) is expected to be collected within 60 days.
Property Taxes Receivable—Current
570,000
Allowance for Uncollectible—Current
Revenues—Property Taxes
To record the property tax levy.
525,000
Property Taxes Receivable—Current
Property Taxes Receivable—Delinquent
To record property tax collections.
10,000
560,000
Cash
513,000
12,000
12-74
Group Exercise:
Requirement 1 (Journal Entries)
2. The city levied property taxes totaling $570,000. Of this
amount, $10,000 was estimated to be uncollectible.
Collections during the year totaled $525,000, of which
$12,000 were associated with property taxes levied in the
prior year that had been declared delinquent at the end of the
prior year. All of the remaining property taxes receivable at
the beginning of the current year, totaling $5,000, were
written off as uncollectible. The net realizable amount at
6/30/X8 ($11,000) is expected to be collected within 60 days.
Property Taxes
Receivable—Delinquent
BB 17,000
Allowance for
Uncollectibles—Delinquent
NRV = 11,000
6,000 BB
12,000 Collected
Given 5,000
5,000
Write
off
5,000
1,000 Left over
Close out 12-75
Group Exercise:
Requirement 1 (Journal Entries)
Allowance for Uncollectibles—Delinquent 6,000
Property Taxes Receivable—Delinquent
5,000
Revenues—Property Taxes
1,000
To write-off uncollectible accounts and eliminate the
remaining $1,000 credit balance in the allowance account.
Property Taxes
Receivable—Delinquent
Allowance for
Uncollectibles—Delinquent
BB 17,000
6,000 BB
12,000 Collected
Given 5,000
5,000
Write
off
5,000
1,000 Left over
Close out 12-76
Group Exercise:
Requirement 1 (Journal Entries)
2. The city levied property taxes totaling $570,000. Of this
amount, $10,000 was estimated to be uncollectible.
Collections during the year totaled $525,000, of which
$12,000 were associated with property taxes levied in the
prior year that had been declared delinquent at the end of the
prior year. All of the remaining property taxes receivable at
the beginning of the current year, totaling $5,000, were
written off as uncollectible. The net realizable amount at
6/30/X8 ($11,000) is expected to be collected within 60 days.
Property Taxes Receivable—Delinquent
57,000
Property Taxes Receivable—Current
Allowance for Uncollectibles—Current
10,000
Allowance for Uncollectibles—Delinquent
To transfer delinquent property taxes to specifically
designated accounts.
57,000
10,000
12-77
Group Exercise:
Requirement 1 (Journal Entries)
3. The estimated revenues for the year include a $44,000
entitlement from the federal government. During the year,
the city received $50,000.
Entitlement Receivable
44,000
Revenues—Entitlements
To record entitlement from the federal government.
Cash
Entitlement Receivable
Revenues—Entitlements
To record collection of entitlement.
44,000
50,000
44,000
6,000
12-78
Group Exercise:
Requirement 1 (Journal Entries)
4. The City’s income taxes, sales taxes, permits, licenses, and
other miscellaneous revenues totaled 225,000.
Cash
225,000
Revenues—Other
225,000
To record revenues accounted for on the cash basis.
12-79
Group Exercise:
Requirement 1 (Journal Entries)
5. Encumbrances outstanding at the beginning of the year
totaled $60,000. The goods and services related to these
encumbrances were received along with invoices for $58,000.
Fund Balance Assigned for Encumbrances 60,000
Unassigned Fund Balance
60,000
To reverse the 6/30/X7 appropriation of fund balance for
encumbrances outstanding.
ENCUMBRANCES
60,000
BUDGETARY FUND BALANCE
ASSIGNED FOR ENCUMBRANCES
To reestablish budgetary control over encumbrances
outstanding at 6/30/X7.
60,000
12-80
Group Exercise:
Requirement 1 (Journal Entries)
5. Encumbrances outstanding at the beginning of the year
totaled $60,000. The goods and services related to these
encumbrances were received along with invoices for $58,000.
BUDGETARY FUND BALANCE
ASSIGNED FOR ENCUMBRANCES
60,000
ENCUMBRANCES
60,000
To cancel encumbrances of $60,000 upon receipt of goods and
services totaling $58,000.
Expenditures
58,000
Vouchers Payable
58,000
To record expenditures of $58,000 for goods and services.
12-81
Group Exercise:
Requirement 1 (Journal Entries)
6. Purchase orders and contracts totaling $380,000 were
entered into during the year. For $340,000 of this amount,
invoices that totaled $336,000 for services and goods were
received. The city generally allows encumbrances
outstanding at year-end to laps but reappropriates the
amounts in the following year to honor the encumbrances.
Of the $336,000 invoiced, $75,000 relates to the acquisition
of supplies inventory. The city uses the consumption
method for accounting for supplies.
ENCUMBRANCES
380,000
BUDGETARY FUND BALANCE
ASSIGNED FOR ENCUMBRANCES
380,000
To record encumbrances for purchase orders issued and
contracts entered into during the year.
12-82
Group Exercise:
Requirement 1 (Journal Entries)
6. Purchase orders and contracts totaling $380,000 were
entered into during the year. For $340,000 of this amount,
invoices that totaled $336,000 for services and goods were
received. The city generally allows encumbrances
outstanding at year-end to laps but reappropriates the
amounts in the following year to honor the encumbrances.
Of the $336,000 invoiced, $75,000 relates to the acquisition
of supplies inventory. The city uses the consumption
method for accounting for supplies.
BUDGETARY FUND BALANCE
ASSIGNED FOR ENCUMBUMBRANCES
340,000
ENCUMBRANCES
340,000
To cancel encumbrances of $340,000 upon receipt of goods
and services totaling $336,000.
Expenditures
281,000
Inventory
75,000
Vouchers Payable
336,000
To record expenditures of $281,000 and the acquisition of
supplies inventory of $75,000, the total of which was previously
encumbered for $340,000.
12-83
Group Exercise:
Requirement 1 (Journal Entries)
7. Payroll and other items not involving the use of purchase
orders and contracts totaled $270,000. This amount does
not include interfund billings.
Expenditures
270,000
Vouchers Payable
270,000
To record expenditures for items not previously encumbered
(other than amounts relating to interfund billings).
8. Cash disbursements (not including payments to other
funds) totaled $750,000.
Vouchers Payable
750,000
Cash
To record cash disbursements other than interfund
disbursements.
750,000
12-84
Group Exercise:
Requirement 1 (Journal Entries)
9. The Auto Repair internal service fund was discontinued as
determined by the city council at the beginning of the year.
The actual amount disbursed to the General Fund when the
fund was discontinued was $22,000.
Cash
22,000
Other Financial Sources—Transfer In
22,000
To record transfer received from the Motor Pool Internal
Service Fund, which was discontinued.
10. A payment was made for $30,000 to the Electric Utility
Enterprise Fund to make up its operating deficit, which had
originally been estimated to be $35,000.
Other Financing Uses—Transfer Out
30,000
Cash
30,000
To record payment of transfer to the Electric Utility Enterprise
Fund ($5,000 under $35,000 budgeted amount).
12-85
Group Exercise:
Requirement 1 (Journal Entries)
11. A $20,000 payment was made to a Capital Projects fund to
cover a portion of street improvements (which was exactly
the amount budgeted).
Other Financing Uses—Transfer Out
20,000
Cash
20,000
To record payment of transfer to a Capital Projects Fund.
12-86
Group Exercise:
Requirement 1 (Journal Entries)
12. The Electric Utility Enterprise fund billed the city for a total
of $28,000 for electricity used by the city and supplied by
the Electric Utility. The cash disbursements throughout the
year for periodic billings totaled $24,000.
Expenditures
28,000
Due to Electric Utility Enterprise Fund
28,000
To record as expenditures electricity purchased from the
Electric Utility Enterprise Fund (a quasi-external transaction).
Due to Electric Utility Enterprise Fund
24,000
Cash
24,000
To record payments made to the Electric Utility Enterprise
Fund for electricity purchased.
12-87
Group Exercise:
Requirement 1 (Journal Entries)
13. The City disbursed $79,000 to the City Center for the
Performing Arts Enterprise Fund as a loan. The repayment
is expected in three years.
Advance to Center for Performing
Arts Enterprising Fund
79,000
Cash
79,000
To record advance to Center Performing Arts Enterprise Fund
(repayable in three years).
12-88
Group Exercise:
Requirement 1 (Journal Entries)
14. A physical count of the supplies inventory at year-end
indicates that the balance decreased from $44,000 to
$41,000 during the year.
Expenditures
78,000
Inventory
78,000
Note: Supplies purchased during the year totaled $75,000 as
indicated in #6. Moreover, the physical inventory decreased
$3,000 from the beginning of the year. Thus, inventory
consumed must be $78,000 ($75,000 + $3,000 ).
12-89
Group Exercise:
Requirement 2 (Closing Entries)
APPROPRIATIONS
720,000
APPROPRIATIONS—TRANSFER OUT
55,000
BUDGETARY FUND BALANCE UNASSIGNED 70,000
ESTIMATED REVENUES
820,000
ESTIMATED TRANSFER IN
25,000
To reverse the entry previously made to record the legally
adopted annual operating budget.
Revenues
831,000
Other Financing Sources—Transfer In
22,000
Expenditures
715,000
Other Financing Uses—Transfer Out
50,000
Unassigned Fund Balance
93,000
To close the actual revenues, expenditures, and other
financing uses into Unassigned Fund Balance.
12-90
Group Exercise:
Requirement 2 (Closing Entries)
BUDGETARY FUND BALANCE
ASSIGNED FOR ENCUMBRANCES
40,000
ENCUMBRANCES
40,000
To close encumbrances outstanding at year-end by reversing
the entry that previously recorded them (see #6).
Unassigned Fund Balance
40,000
Fund Balance Assigned for Encumbrances
40,000
To record the actual fund balance reserve account to indicate
the portion of year-end fund balance segregated for
expenditure upon vendor performance.
12-91
Group Exercise: Requirement 2 (Statement of Revenues,
Expenditures, and Changes in Fund Balance)
Variance
Actual(Unfavorable)
Favorable
Property taxes ($560,000 + $1,000) $570,000)
$(9,000))
Intergovernmental entitlement
44,000)
6,000)
Miscellaneous 206,000) 225,000)
Total Revenues$820,000)
$16,000)
$561,000)
Budget
Revenues:
Expenditures:
Excess of Revenues over Expenditures
50,000)
19,000)
$836,000)
720,000)
715,000) 5,000)
$100,000) $121,000) $21,000)
Other Financing Sources (Uses):
Transfer in from Auto RepairInternal Service Fund
$25,000)
$22,000)
$(3,000)
Transfers Out—
to Electric Utility Enterprise Fund (35,000)
(30,000)
5,000)
to Capital Projects Fund (20,000) (20,000)
0)
Total Other Financing Sources (Uses) $(30,000)
$(28,000) $2,000)
Excess of Revenues over Expenditures
and Other Financing Uses:
$70,000) $93,000) $(7,000)
Fund Balance – 7/1/X7 100,000) 100,000)
Fund Balance – 6/30/X8
$170,000)
$23,000)
0)
$193,000)
)
Note: The large favorable variance is attributable primarily to encumbrances of $40,000 outstanding at year-end that will be reflected as expenditures in the
following year.
12-92
Group Exercise:
Requirement 4 (Fund Balance Summary)
Fund Balance:
Inventory
Services
Nonspendable:
Supplies
$ 41,000
Spendable:
Assigned for
Governmental
40,000
Unassigned
112,000
Balance
Total Fund
$193,000
12-93
Learning Objective 8
Make calculations and record
journal entries for basic
interfund activities.
12-94
Interfund Activities
12-95
Overview of Accounting and Financial Reporting for
the General Fund
12-96
Overview of Accounting and Financial Reporting for
the General Fund
12-97
Conclusion
The End
Chapter 10
Partnerships: Formation,
Operation, and Changes in
Membership
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Comprehensive Partnership Creation Problem
The partnerships of Brad & Mike (B&M) and
Austin and Justin (A&J) began business on 1/1/X1;
each partnership owns one retail appliance store. The
two partnerships agree to combine as of 7/1/X8 to
form a new partnership, BAM-J Discount Stores.
REQUIRED
Given the information on the next two slides,
1. Prepare the journal entries to record the initial capital
contribution after considering the effect of this information.
Use separate entries for each of the combining partnerships.
2. Prepare a schedule computing the cash contributed or
withdrawn by each partner to bring the initial capital balances
into the profit and loss sharing ratio.
10-2
Learning Objective 1
Understand and explain the
nature and regulation of
partnerships.
10-3
What is a Partnership?
 An association of two or
more persons who
◼
◼
are co-owners of a
business, and
share profits and losses
in an agreed-upon
manner.
A
B
ABC
Company
10-4
What is a “Person”?
 An individual
 A corporation
 Another partnership
Z Corp
T&D
Partnership
10-5
Partnerships: Pros & Cons
 Advantages
◼
Ease of formation
◼
Lack of formality
◼
Single taxation (see following slide)
 Disadvantages
◼
Unlimited liability (for general partnerships)
◼
Difficulty in disposing of partnership interests
◼
Mutual agency
10-6
Partnership Form of Organization: Income Tax
Reporting
 Single Taxation of Partnership
Earnings
◼
◼
◼
Partnerships only report their
earnings—they are not taxed at the
business entity level (as are
corporations).
Partnerships file IRS Form 1065,
which shows the allocation of profits
among partners.
Partners report their share of profits
on their individual IRS Form 1040
return.
Uncle Sam
A
B
AB
Partnership
10-7
Regulation
 Each state regulates the partnerships
that are formed in it.
 Most states begin with a model act and
then modifies it to fit that state’s
business culture and history.
 Most have now adopted the Uniform
Partnership Act of 1997 (UPA 1997) as
their model act.
10-8
Regulation: The Uniform Partnership Act (UPA)
 The UPA 1997 covers:
◼
◼
◼
Relations of partners to one another.
Relations of partners to persons dealing
with the partnership.
Dissolution and winding up of the
partnership.
10-9
The Partnership Agreement
 What is a partnership agreement?
 A written expression of what the
partners have agreed to.
 Examples of areas addressed:
◼
Manner of sharing profits.
◼
Limitations on withdrawals.
◼
Rights of partners.
◼
Settling with withdrawing partners.
◼
Expulsion of partners.
◼
Conflicts of interest.
10-10
Practice Quiz Question #1
Which of the following is not one of
the advantages of general
partnerships?
a. Ease of formation
b. Unlimited liability
c. Lack of formality
d. Single taxation
10-11
Practice Quiz Question #1 Solution
Which of the following is not one of
the advantages of general
partnerships?
a. Ease of formation
b. Unlimited liability
c. Lack of formality
d. Single taxation
10-12
Learning Objective 2
Understand and explain the
differences among different
types of partnerships.
10-13
Types of Partnerships
 General Partnerships
◼
◼
All partners have unlimited liability.
Creditors can go after the personal assets of
any or all of the partners.
10-14
Types of Partnerships
 Limited Partnerships
◼
Limited partners have limited liability to
partnership creditors if the partnership is unable
to pay its debts.
⚫ Limited partners’ risk is limited to their invested
capital.
⚫ Thus, personal assets are not at risk.
◼
At least one of the partners must be a general
partner.
10-15
Types of Partnerships
 Limited Liability Partnerships (LLPs)
◼
A partner’s personal assets are at risk only for
⚫ his or her own negligence and wrongdoing,
⚫ the negligence and wrongdoing of those under his or
her control, but
⚫ not debts.
◼
Since 1993, many accounting firms have changed
from general partnerships to LLPs.
10-16
Types of Partnerships
 Limited Liability Limited Partnerships
(LLLPs)
◼
◼
◼
Like a limited partnership, must have at least one
general partner.
General partners manage the partnership.
Big difference relates to the liability of general
partners:
⚫ No personal liability for partnership obligations (like a
limited partner)
⚫ Not liable for wrongdoing of other partners—just
personal decisions and decisions of those supervised
10-17
Practice Quiz Question #2
Which of the following statements is true?
a. The partners in a general partnership
have limited liability.
b. At least two of the partners in a limited
partnership must be general partners.
c. Partners in an LLP are not responsible
for their own actions.
d. Limited liability limited partnerships
must have at least one general partner.
10-18
Practice Quiz Question #2 Solution
Which of the following statements is true?
a. The partners in a general partnership
have limited liability.
b. At least two of the partners in a limited
partnership must be general partners.
c. Partners in an LLP are not responsible
for their own actions.
d. Limited liability limited partnerships
must have at least one general partner.
10-19
Learning Objective 3
Make calculations and journal
entries for the formation of
partnerships.
10-20
Partners’ Accounts
 Each partner can have
◼
◼
◼
a capital account.
a drawing account (a contra capital
account—closed out at year-end).
a loan account (loans usually earn
interest—a partnership expense).
 Partnerships do NOT use a
retained earnings account.
DR
CR
10-21
Recording Capital Contributions
 Keep it FAIR!
◼
Current Fair Market
Values should be used to
record
⚫ noncash assets contributed
to a partnership.
⚫ liabilities assumed by a
partnership.
ABC
Partnership
10-22
Partnership Formation Example
Brian and Spencer wish to form the B&S partnership.
Brian contributes land with a book value of $65,000
and a current value of $150,000 and a building with a
book value of $142,000 and a current value of
$175,000. Spencer will contribute cash.
If the partners plan to share profits and losses equally
after the formation of the partnership and assuming
they have agreed to equal capital contributions, how
much cash will Spencer have to contribute to form the
partnership?
$150,000 + $175,000 = $325,000
10-23
Comprehensive Partnership Creation Problem
1. Profit and loss ratios. The profit and loss sharing ratios for the former partnerships were
40% to Brad and 60% to Mike, and 30% to Austin and 70% to Justin. The profit and loss
sharing ratio for the new partnership is Brad, 20%; Mike, 30%; Austin, 15%; and Justin, 35%.
2. Capital investments. The opening capital investments for the new partnership are to be in
the same ratio as the profit and loss sharing ratios for the new partnership. If necessary,
certain partners may have to contribute additional cash, and others may have to withdraw
cash to bring the capital investments into the proper ratio.
3. Accounts receivable. The partners agreed to set the new partnership’s allowance for bad
debts at 3% of the accounts receivable contributed by B&M and 12% of the accounts
receivable contributed by A&J.
4. Inventory. The new partnership’s opening inventory is to be valued by the FIFO method.
B&M used the FIFO method to value inventory (which approximates its current value), and
A&J used the LIFO method. The LIFO inventory represents 85% of its FIFO value.
5. Property and equipment. The partners agree that the building’s current value is
approximately 70% of the building’s historical cost, as recorded on each partnership’s books.
6. Unpaid liability. After each partnership’s books were closed on 6/30/X8, an unrecorded
merchandise purchase of $1,500 by A&J was discovered. The merchandise had been sold by
6/30/X8.
7. The 6/30/X8 postclosing trial balances of the partnerships follow.
10-24
Comprehensive Partnership Creation Problem
Account
Cash
Accounts Receivable
Allowance for doubtful accounts
Inventory
Building & Equipment
Accumulated Depreciation
Accounts Payable
Notes Payable
Brad, Capital
Mike, Capital
Austin, Capital
Justin, Capital
Totals
Brad & Mike Trial
Balance – June 30, 20X8
25,000
100,000
2,000
175,000
105,000
24,000
40,000
100,000
95,000
144,000
405,000
405,000
Austin & Justin Trial
Balance – June 30, 20X8
22,000
150,000
6,000
119,000
160,000
61,000
60,000
120,000
451,000
65,000
139,000
451,000
1. Prepare the journal entries to record the initial capital contribution after considering the
effect of this information. Use separate entries for each of the combining partnerships.
2. Prepare a schedule computing the cash contributed or withdrawn by each partner to
bring the initial capital balances into the profit and los sharing ratio.
10-25
Comprehensive Problem Solution
PART 1
Summary of changes to carrying values:
Brad & Mike
Austin & Justin
Increase allowance for bad debt
$(1,000)
$(12,000)
Increase inventory
21,000)
Increase buildings and equipment
(7,500)
Increase accounts payable
13,000)
(1,500)
Net increase
$(8,500)
$20,500)
Allocate to:
Brad (40%)
$(3,400)
Austin (30%)
$6,150
Mike (60%)
(5,100)
Justin (70%)
14,350
$(8,500)
$20,500
10-26
Comprehensive Problem Solution
Brad & Mike Journal Entry:
Cash
Accounts Receivable
Allowance for doubtful accounts
Inventory
Building & Equipment
Accounts Payable
Notes Payable
Brad, Capital
Mike, Capital
25,000
100,000
3,000
75,000
73,500
40,000
100,000
91,600
138,900
10-27
Comprehensive Problem Solution
Austin & Justin Journal Entry:
Cash
Accounts Receivable
Allowance for doubtful accounts
Inventory
Building & Equipment
Accounts Payable
Notes Payable
Austin, Capital
Justin, Capital
22,000
150,000
18,000
140,000
112,000
61,500
120,000
71,150
153,350
10-28
Comprehensive Problem Solution
PART 2
Brad
Mike
Austin
Justin
Profit sharing percentage
20%
30%
15%
35%
Capital balances
91,600 138,900
71,150 153,350 455,000
Capital balances required
using profit and loss
sharing percentages
91,000 136,500
68,250 159,250
Capital contribution or
(withdrawal)
(600)
(2,900)
(2,400)
Total
5,900
10-29
Learning Objective 4
Make calculations and journal
entries for the operation of
partnerships.
10-30
Accounting for Operations of a Partnership
 Partners’ accounts
◼
Capital accounts
⚫
⚫
Used to record the initial investment of a partner, any
subsequent capital contributions, profit or loss
distributions, and any withdrawals of capital by the
partner
Deficiencies are usually eliminated by additional
capital contributions
Capital
Investment
Contributions
% Loss
% Profit
10-31
Accounting for Operations of a Partnership
 Partners’ accounts
◼
Drawing accounts
⚫
⚫
◼
Used to record periodic withdrawals and is then
closed to the partner’s capital account at the end of
the period
Noncash drawings are valued at their market values
at the date of the withdrawal
Loan accounts
⚫
⚫
A loan from a partner is shown as a payable on the
partnership’s books
Unless all partners agree otherwise, the partnership
is obligated to pay interest on the loan
10-32
Practice Quiz Question #3
Which of the following would result in
a reduction to a partner’s capital
account?
a. The initial investment.
b. The allocation of a profit.
c. Additional capital contributions.
d. A withdrawal.
e. A loan to a partner.
10-33
Practice Quiz Question #3 Solution
Which of the following would result in
a reduction to a partner’s capital
account?
a. The initial investment.
b. The allocation of a profit.
c. Additional capital contributions.
d. A withdrawal.
e. A loan to a partner.
10-34
Learning Objective 5
Make calculations and journal
entries for the allocation of
partnership profit or loss.
10-35
Income Allocation Example
Assume that in its first year of operation, B&S
partnership earns $162,000 of income.
What journal entry would B&S make to allocate
the profits between the two partners?
Profit & Loss Summary
Capital, Brian
Capital, Spencer
162,000
81,000
81,000
10-36
Sharing Profits and Losses
 Partners can share profits and losses in
any way they choose.
 Possible ways include
◼
ratios.
◼
salary allowances and ratios.
◼
imputed interest on capital, salary
allowances, and ratios.
◼
capital balances only.
◼
performance methods.
10-37
Group Exercise 1: Allocating Profit and Loss,
No Restrictions
The partnership of Alex and James has the following provisions:
• Alex and James receive salary allowances of $37,000 and $18,000,
respectively.
• Interest is imputed at 10% on the average capital investment.
• Any remaining profit or loss is shared between Alex and James in
a 3:2 ratio, respectively.
• Average Capital investments: Alex, $ 50,000; James, 130,000
REQUIRED
1. Prepare a schedule showing how the profit would be divided,
assuming the partnership profit or loss is:
a. $ 102,000
b. $ 57,000
c. $(34,000)
2. What journal entry should be made to allocate the profit or loss
for each of the three cases listed above?
10-38
Group Exercise 1: Solution for part a
ALLOCATED TO
Alex
James
Total Profit
Salary
Interest on Capital
Residual Profit
Allocate Profit
Income Summary
Capital, Alex
Capital, James
37,000
5,000
18,000
13,000
17,400
59,400
11,600
42,600
Total
102,000)
(55,000)
(18,000)
29,000
(29,000)
0
102,000
59,400
42,600
10-39
Group Exercise 1: Allocating Profit and Loss,
No Restrictions
The partnership of Alex and James has the following provisions:
• Alex and James receive salary allowances of $37,000 and $18,000,
respectively.
• Interest is imputed at 10% on the average capital investment.
• Any remaining profit or loss is shared between Alex and James in
a 3:2 ratio, respectively.
• Average Capital investments: Alex, $ 50,000; James, 130,000
REQUIRED
1. Prepare a schedule showing how the profit would be divided,
assuming the partnership profit or loss is:
a. $ 102,000
b. $ 57,000
c. $(34,000)
2. What journal entry should be made to allocate the profit or loss
for each of the three cases listed above?
10-40
Group Exercise 1: Solution for part b
ALLOCATED TO
Alex
James
Total Profit
Salary
Interest on Capital
Residual Profit
Allocate Profit
Income Summary
Capital, Alex
Capital, James
37,000) 18,000)
5,000) 13,000)
(9,600) (6,400)
32,400) 24,600)
Total
57,000)
(55,000)
(18,000)
(16,000)
16,000)
0)
57,000
32,400
24,600
10-41
Group Exercise 1: Solution for part c
ALLOCATED TO
Alex
James
Total Profit
Salary
Interest on Capital
Residual Profit
Allocate Profit
Capital, Alex
Capital, James
Income Summary
Total
(34,000)
37,000) 18,000) (55,000)
5,000) 13,000) (18,000)
(107,000)
(64,200) (42,800) 107,000)
(22,200) (11,800)
0)
22,200
11,800
34,000
10-42
Methods to Share Profits and Losses: “To the
Extent Possible” Limitations
 When a “limit” provision exists:
◼
The next lower level method of sharing can be
reached if and only if there is still unallocated
profit remaining after dealing with the current
level.
10-43
Group Exercise 2: Allocating Profit and Loss—
“Limit”
Assume the same information provided in Group Exercise 1,
except that the partnership agreement stipulates the following
order of priority:
1. Salary allowances (only to the extent available)
2. Imputed interest on average capital investments (only to
the extent available).
3. Any remaining profit in a 3:2 ratio. (No mention is made
regarding losses.)
REQUIRED:
The requirements are the same as for Group Exercise 1 (i.e.,
calculate the allocations and prepare journal entries).
a. $ 102,000
b. $ 57,000
c. $ (34,000)
10-44
Group Exercise 2: Solution for part a
ALLOCATED TO
Alex
James
Total Profit
Salary
Interest on Capital
Residual Profit
Allocate Profit
Income Summary
Capital, Alex
Capital, James
37,000) 18,000)
5,000) 13,000)
17,400) 11,600)
59,400) 42,600)
Total
102,000)
(55,000)
(18,000)
29,000)
(29,000)
0)
102,000
59,400
42,600
10-45
Group Exercise 2: Solution for part b
ALLOCATED TO
Alex
James
Total Profit
Salary
Interest on Capital *
Residual Profit
Allocate Profit
37,000)
18,000)
556)
1,444)
0)
37,556)
0)
19,444)
Total
57,000)
(55,000)
2,000)
(2,000)
0)
0)
0)
* $2,000 x (5,000 ÷ $18,000) = 556
$2,000 x ($13,000 ÷ $18,000) = 1,444
Income Summary
Capital, Alex
Capital, James
57,000
37,556
19,444
10-46
Group Exercise 2: Solution for part c
In this case, the partnership agreement is
vague. An argument can be made for allocating
the loss equally pursuant the UPA 1997 because
the partnership agreement is silent with respect
to losses.
Alternatively, we could presume that losses were
intended to be shared in the residual profitsharing ratio.
In these cases, the accountant should seek
clarification from each partner.
10-47
Practice Quiz Question #4
Matt and Chad created a partnership (M&C)
on 12/31/X8 (sharing profits 50/50). Matt
contributed equipment from his sole
proprietorship having a carrying value of
$4,000 and a fair value of $8,000. In 20X9,
M&C had profits of $96,000 and borrowed
$20,000 from a bank. In 2009, Matt withdrew
$35,000 cash. Matt’s Y/E capital balance is
a. $11,000.
b. $17,000.
c. $21,000.
d. $56,000.
10-48
Practice Quiz Question #4 Solution
Matt and Chad created a partnership (M&C)
on 12/31/X8 (sharing profits 50/50). Matt
contributed equipment from his sole
proprietorship having a carrying value of
$4,000 and a fair value of $8,000. In 20X9,
M&C had profits of $96,000 and borrowed
$20,000 from a bank. In 2009, Matt withdrew
$35,000 cash. Matt’s Y/E capital balance is
a. $11,000.
b. $17,000.
c. $21,000 ($8,000 + $96,000/2 – $35,000)
d. $56,000.
10-49
Learning Objective 6
Make calculations and journal
entries to account for changes in
partnership ownership.
10-50
Partner’s Admission: Purchase of An Existing
Interest
 The purchase of an interest from
one or more of a partnership’s
existing partners is a:
◼
personal transaction between the
incoming partner and the selling
partner(s).
 The only entry required on the
partnership’s books is to transfer
an amount:
◼
◼
from the selling partner’s Capital
account.
C
Interest $
A
B
AB
Partnership
to the new partner’s Capital account.
10-51
Partner’s Admission: Adding a New Partner
 Key Objective
◼
Achieve equity among the partners
A
B
AB
Partnership
A
C
+ Assets =
B
C
ABC
Partnership
10-52
How to Achieve Equity?
A
B
AB
Partnership
A
C
+ Assets =
B
C
ABC
Partnership
Example
Cash
$100,000
Capital, A
$100,000
Land
100,000
Capital, B
100,000
Total Assets
$200,000
Total Equity
$200,000
➔ How much would C have to contribute?
➔ What factors would you have to consider?
10-53
How to Achieve Equity?
Example
Cash
$100,000
Capital, A
$100,000
Land
100,000
Capital, B
100,000
Total Assets
$200,000
Total Equity
$200,000
Q: What if the land has a current value of $200,000?
 Assume C contributes $150,000 (FMV of value
owned by A and B) for a 1/3 interest in assets,
profits, and losses.
Q: What if the land is sold the next day for $200,000?
10-54
Minimizing Inequities
 The Three Methods
◼
The revaluing of assets / goodwill method.
◼
The bonus method.
◼
The special profit-and-loss sharing
provision method.
 Some methods can still result in
inequities if events do not materialize as
assumed.
≠
10-55
Minimizing Inequities
 The Three Methods
◼
The revaluing of assets / goodwill method.
◼
The bonus method.
◼
The special profit-and-loss sharing
provision method.
 Some methods can still result in
inequities if events do not materialize as
assumed.
≠
10-56
(1) Revaluing of Assets Method
Q: What if the land has a current value of $200,000?
A: Simply “revalue” the land before admitting C!
Land
Capital, A
Capital, B
100,000
50,000
50,000
Cash
$100,000
Capital, A
$150,000
Land
200,000
Capital, B
150,000
Total Assets
$300,000
Total Equity
$300,000
Q: How do you record C’s contribution?
Cash
Capital, C
150,000
150,000
Q: What if the land is sold two years later for $230,000?
A: Each gets $10,000 of gain.
10-57
(2) Bonus Method
Q: Given that the land has a current value of $200,000?
The partners agree to share equally in all future gains or
losses on the disposal of the land. However, C’s capital
account is decreased up front by the amount of the first
$100,000 of gain that he/she will receive ($33,333). This
decrease is added to A’s and B’s capital accounts up front.
Cash
Capital, A
Capital, B
Capital, C
150,000
16,667
16,667
116,667
Q: What if the land is sold two years later for $230,000?
A: Each gets $43,333 of gain.
10-58
(3) Special Profit and Loss Sharing Provision
Q: Given that the land has a current value of $200,000?
Specify in the new partnership agreement that the land’s
current value is $200,000 and that partners A and B share
equally (or in some other specified manner) in the first
$100,000 of gain when the land is disposed of.
Cash
Capital, C
150,000
150,000
Q: What if the land is sold two years later for $230,000?
A: A and B share equally in the first $100,000 of gain and all
partners share equally in the additional $30,000 of gain.
A and B each get $60,000 and C gets $10,000 of the gain.
10-59
Summary of the Three Methods: Before Land
is Sold for $230,000
(1) Revaluing Cash
of assets
Land
Total Assets
$250,000
200,000
$450,000
Capital, A
Capital, B
Capital, C
Total Equity
$150,000
150,000
150,000
$450,000
Gain of $30,000 allocated equally to A, B, & C ($10,000 each)
(2) Bonus
Cash
$250,000
Land
Total Assets
100,000
$350,000
Capital, A
Capital, B
Capital, C
Total Equity
$116,667
116,667
116,667
$350,000
Gain of $130,000 allocated equally to A, B, & C ($43,333 each)
(3) Special
P&L
Sharing
Cash
$250,000
Land
Total Assets
100,000
$350,000
Capital, A
Capital, B
Capital, C
Total Equity
$100,000
100,000
150,000
$350,000
Gain of $130,000: allocate $60,000 to A & B and $10,000 to C
10-60
Summary of the Three Methods: After Land is
Sold for $230,000
(1) Revaluing Cash
of assets
(2) Bonus
(3) Special
P&L
Sharing
$480,000
Total Assets
$480,000
Cash
$480,000
Total Assets
$480,000
Cash
$480,000
Total Assets
$480,000
Capital, A
Capital, B
Capital, C
Total Equity
$160,000
160,000
160,000
$480,000
Capital, A
Capital, B
Capital, C
Total Equity
$160,000
160,000
160,000
$480,000
Capital, A
Capital, B
Capital, C
Total Equity
$160,000
160,000
160,000
$480,000
We get the same result under each method!
10-61
Minimizing Inequities
 Only the special profit-and loss sharing
provision method will prevent an
inequity to one or more of the partners in
the event that
◼
◼
the agreed-upon values of the assets are
erroneous.
the agreed-upon value of goodwill does not
materialize.
≠
10-62
Key Differences Between Revaluation /
Goodwill and Bonus Methods
Revaluation/Goodwill Method
Revalue the balance sheet by
recording goodwill or revaluing
tangible assets.
◼ Thus, we now have a bigger “pie”
to divide up among the partners.
Excess Value
◼
Land
Capital, A
Capital, B
Book Value
of Net Assets
100,000
50,000
50,000
10-63
Key Differences Between Revaluation /
Goodwill and Bonus Methods
Revaluation/Goodwill Method
Revalue the balance sheet by
recording goodwill or revaluing
tangible assets.
◼ Thus, we now have a bigger “pie”
to divide up among the partners.
◼ The new partner’s capital account
will be equal to his/her ownership
percentage of the “Big Pie.”
Land = $100,000
◼
Cash
Capital, C
Small Pie =
200,000 +
150,000 =
350,000
x 1/3 =
$150,000
150,000
150,000
10-64
Key Differences Between Revaluation /
Goodwill and Bonus Methods
Bonus Method
Do not revalue the balance sheet.
◼ Only leaves the book value of
tangible net assets on the balance
sheet.
◼
Book Value
of Net Assets
10-65
Key Differences Between Revaluation /
Goodwill and Bonus Methods
Bonus Method
Do not revalue the balance sheet.
◼ Only leaves the book value of
tangible net assets on the balance
sheet.
◼ The new partner’s capital account
will be equal to his/her ownership
percentage of the “Small Pie.”
◼
Cash
Capital, A
Capital, B
Capital, C
Small Pie =
200,000 +
150,000 =
350,000
x 1/3 =
$116,667
150,000
16,667
16,667
116,667
10-66
The Revaluing of Assets / Goodwill Method
 Advantages
◼
◼
Credit to incoming partner always at least
equal to cash contribution
Can be important “psychologically”
 Disadvantages
◼
Departs from GAAP
◼
Complicates income tax preparation
10-67
The Bonus Method
 Major Advantages
◼
Does not result in a departure from GAAP
◼
Minimizes bookkeeping and tax return effort
 Major Disadvantages
◼
A portion of one or more partner’s capital balance
is transferred to one or more other partners.
⚫ The hope is that the transferred amount will later be
recouped via future profits.
◼
Incoming partner’s capital account may be less
than his/her cash contribution!
10-68
Determining the Value of Goodwill
Steps to follow:
1. Estimate the implied value of the partnership based on
the new partner’s contribution.
⚫
New capital contribution ÷ new partner ownership %
2. Estimate the implied value of the partnership based on
the old partners’ total equity.
⚫
Total old partner capital balance ÷ total old ownership %
3. Calculate the amount of tangible net assets.
⚫
The sum of old partner capital and new partner contributed
capital.
4. Calculate implied goodwill
⚫
Implied value (greater of 1 or 2) – tangible net assets (3)
5. Determine whether the new or old partners possess
goodwill.
⚫
⚫
The smaller of 1 or 2
The one who paid less for their relative share.
10-69
Practice Quiz Question #5a
Betsy contributes $54,000 cash for a 25% interest
in the new net assets of the partnership (that has
existing equity of $180,000). The old partners
capital accounts are not to decrease (i.e., use the
Revaluation / Goodwill method). Betsy’s capital
account is credited:
a. $ 9,000
b. $54,000
c. $58,500
d. $60,000
e. $76,500
10-70
Solution, Summary
1. New implied value: $ 54,000 ÷
25% = $ 216,000
2. Old implied value:
$180,000 ÷
75% = $ 240,000
3. Tangible net assets: $180,000 + $54,000 = $ 234,000
4. Implied Goodwill = $240,000 − $234,000 = $ 6,000
5. Goodwill belongs to new partner (because
$216,000 is less than $240,000). [Implies that
she paid less for her relative share of the business.]
Since we’re evaluating, use the BIG pie:
GW = 6,000
The BIG PIE (Tangible + Goodwill)
234,000
The SMALL PIE (Tangible Only)
x 25% = $60,000
10-71
Practice Quiz Question #5a Solution
Betsy contributes $54,000 cash for a 25% interest
in the new net assets of the partnership (that has
existing equity of $180,000). The old partners
capital accounts are not to decrease (i.e., use the
Revaluation / Goodwill method). Betsy’s capital
account is credited:
Cash
54,000
a. $ 9,000
6,000
b. $54,000 Goodwill
Capital, Betsy
60,000
c. $58,500
d. $60,000 ($240,000 x 25%)
e. $76,500
Betsy’s share of the “big pie.”
10-72
Practice Quiz Question #5b
Betsy contributes $54,000 cash for a 25%
interest in the new net assets of the partnership
(that has existing equity of $180,000). Use the
Bonus Method. Betsy’s capital account is
credited
a. $ 9,000.
b. $54,000.
c. $58,500.
d. $60,000.
e. $76,500.
10-73
Solution, Summary
1. New implied value: $ 54,000 ÷
25% = $ 216,000
2. Old implied value:
$180,000 ÷
75% = $ 240,000
3. Tangible net assets: $180,000 + $54,000 = $ 234,000
4. Implied Goodwill = $240,000 − $234,000 = $ 6,000
5. Goodwill belongs to new partner (because
$216,000 is less than $240,000). [Implies that
she paid less for her relative share of the business.]
Since we’re evaluating, use the BIG pie:
Since we’re not
revaluating, use the The BIG PIE (Tangible + Goodwill)
Small pie:
The SMALL PIE (Tangible Only)
Small Pie
= 180,000
+ 54,000
= 234,000
x 25% = $58,500
10-74
Practice Quiz Question #5b Solution
Betsy contributes $54,000 cash for a 25%
interest in the new net assets of the partnership
(that has existing equity of $180,000). Use th…