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K. Accounting by Governments for Certain Events and Transactions

K. Accounting by Governments for Certain Events and Transactions

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Module 21: Governmental (State and Local) Accounting


hotel-motel tax may have to be used, by legislation, for promotion of tourism. Purpose restrictions do not affect

the timing of revenue recognition.

In order for a receivable and revenue to be recognized, four types of eligibility requirements must

be met. First is the required characteristics of the recipients. The recipient of resources must have the

characteristics required by the provider. For example, the recipient of certain state funds allocated for road

repairs may have to be a county government, a municipality, or a township. Second, time requirements must

be met, if a provider specifies that resources must be expended in a certain future period. For example, if a state

indicates that funds are appropriated for water system improvements for the fiscal year ended June 30, 2012,

then neither a receivable nor revenue would be recognized by the local governments receiving the funds until

that fiscal year. In the absence of specified time requirements, a receivable and revenue would be recognized

when a promise is unconditional. Third, certain grants from one government to another cannot be provided

until the receiving government has expended the funds. This is a condition the GASB calls a reimbursement.

Reimbursement grant revenues are recognized only when expenditures are recognized. Finally, resources

pledged that have a contingency attached are not to be recognized until that contingency is removed.

Derived tax revenues result from taxes assessed by governments on exchange transactions. Examples

include sales taxes, income taxes, and motor fuel taxes. Receivables and revenues are to be recognized when

the underlying transaction (the sale, the income, etc.) takes place. For example, under accrual accounting, if

a state imposed a sales tax of 6%, the state would record a revenue of $6 when a merchant recorded a sale of

$100. If resources are received before the underlying transaction takes place, then the asset would be offset by

revenues received in advance, a liability.

Imposed nonexchange transactions are taxes and other assessments by governments that are not derived

from underlying transactions. Examples include property taxes, special assessments, and fines and forfeits. Assets

from imposed nonexchange transactions should be recognized when an enforceable legal claim exists, or when

the resources are received, whichever occurs first. In the case of property taxes, this would normally be specified

in the enabling legislation, such as the lien or assessment date. Revenues for property taxes should be recognized,

net of estimated refunds and estimated uncollectible taxes, in the period for which the taxes are levied, regardless

of when the enforcement date or collection date might be. All other imposed nonexchange transactions should be

recognized as revenues at the same time as the assets, or as soon as use is first permitted. On the modified accrual

basis, property taxes may not be recognized unless collected within sixty days after the end of a fiscal year.

Government-mandated nonexchange transactions exist when the providing government, such as the

federal government or a state government, requires the receiving government to expend funds for a specific

purpose. For example, a state may require school districts to “mainstream” certain children by including them

in regular classes and also to provide additional assistance in the form of extra aides. Funding for this purpose

would be considered to be a government-mandated nonexchange transaction. Receiving governments should

recognize assets and revenues when all eligibility requirements have been met.

Voluntary nonexchange transactions include grants, entitlements, and financial guarantees provided from

a government to another entity (usually another government) where the providing government does not impose

specific requirements upon the receiving entity. For example, a state provides a grant for new technology for

school districts but does not require those school districts to accept the grant or utilize that technology. Even

though the use of the grant is restricted, it is a voluntary nonexchange transaction. It also includes voluntary

contributions from individuals and other entities to governments. An example of this type of transaction would

be the gift of funds from an individual to a school district or a college. Voluntary nonexchange transactions

may or may not have purpose restrictions. The recognition of assets and revenues would be when all eligibility

requirements have been met, the same as government-mandated nonexchange transactions.

If after a revenue has been recognized by a governmental entity (in a later fiscal year), and those funds must

be returned to the provider, then the recipient government must record an expense and liability (or reduction

of cash). If there is a difference in the provider government’s and recipient government’s fiscal year, then

the provider’s fiscal year would govern for purposes of determining eligibility requirements. If the providing

government, a state, has a biennial fiscal year, then half of the grant would be recognized by the recipient

government in each of the providing government’s two fiscal years.

A government may voluntarily extend a financial guarantee for the obligations of another entity. GASB

Statement No. 70 requires the government to recognize a liability when qualitative factors or historical

data indicate that it is more likely than not that the government will be required to make a payment on the

guarantee. The statement also requires the government to disclose the potential obligation until the government

is released from its obligation.


Accounting for intangible assets. GASB Statement No. 51, Accounting and Financial Reporting for

Intangible Assets, allows only identifiable intangible assets to be recognized as capital assets in the statement

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Module 21: Governmental (State and Local) Accounting


of net position (at historical cost). Costs related to internally generated intangibles (e.g., proprietary software

systems) may begin to be capitalized when

a. The government’s specific objective for the project and the proposed service capacity has been determined,

b.The feasibility of completing the project has been demonstrated, and

c. The government’s intention to complete or to continue the development of the asset has been demonstrated.

Intangible assets should be amortized over their useful lives. An intangible asset that has no legal,

contractual, regulatory, technological, or other factors limiting its useful life should be considered to have

an indefinite useful life and should not be amortized unless its useful life is later determined to be no longer



Sales and pledges of receivables and future revenues. In some situations a state or local government

may decide to sell receivables or future revenues (e.g., future tobacco settlement receipts, or delinquent tax

receivables). GASB Statement No. 48, Sales and Pledges of Receivables and Future Revenues and Intraentity

Transfers of Assets and Future Revenues, provides guidance for accounting for such transactions. Specifically,

this statement provides criteria for determining when the assets have been sold and should be removed from the

government’s financial statements as opposed to treating the transaction as a collateralized loan.

GASB Statement No. 48 establishes that a transaction is a collateralized borrowing unless the government

both transfers the receivables or future revenues and has no continued involvement with them. Circumstances

that would indicate continued involvement and prevent accounting for the transaction as a sale include

The government or the buyer can cancel the sale.

The government can limit the buyer’s ability to subsequently sell or pledge the receivables or future revenue.

The government has access to the receivables, future revenues, or the cash collected from them.

The government can substitute for or reacquire specific receivables without the buyer’s consent.

The government is actively involved in the future generation of sold revenues (e.g., the revenues are the

product of goods or services provided by the government).

Receivables that meet the requirements for sale should be removed from the assets of the selling

government’s financial statements. The difference between the carrying value of the receivables and the funds

received is reported as a gain or loss on accrual-basis financial statements or as revenue in modified-accrualbasis financial statements. In a sale of future revenue, the government reports the proceeds as a deferred inflow

and recognizes the revenue over the life of the sales agreement.

If the transaction does not meet the requirements of a sale, it is accounted for as a collateralized loan. The

proceeds represent a liability that is repaid as the receivables or revenues are collected.


Accounting for derivative instruments. GASB Statement No. 53, Accounting and Financial Reporting

for Derivative Instruments, specifies the appropriate accounting for derivative instruments. State and local

governments use derivative instruments to make investments or manage (hedge) specific risks. The rules for

accounting for these instruments are similar to those for other entities under SFAS 133. Derivative instruments

derive value as a financial instrument from something outside the instrument itself.

Under GASB Statement No. 53, derivative instruments are reported on the statement of net position at their

fair value (except for certain Synthetic Guaranteed Investment Contracts). If the derivative is an investment or

an ineffective hedge, changes in fair value should be reported as investment revenue in the flow of resources

statement. Changes in the values of hedging derivatives are reported as deferred inflows or deferred outflows in

the statement of net position. In proprietary or fiduciary fund-based financial statements, the fund that reports

or expects to report the hedged item should report the hedging derivative instrument.

A derivative is evaluated for effectiveness as a hedge when it is acquired and reevaluated at the end of each

subsequent financial reporting period. Methods used to evaluate the effectiveness include

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1. Consistent critical terms method—evaluates the hedge by qualitatively evaluating the terms of the hedgeable

item and the potential hedging derivative instrument. If the critical terms between the hedgeable item and

the derivative instrument are the same or similar, the instrument is considered to be an effective hedge.

2. Quantitative methods

a. Synthetic instrument method—combines the cash flow effects of the hedgeable item with the

potential hedging derivative instrument to see if they offset.

b. Dollar-offset method—compares changes in the fair value (or expected cash flows) of the hedgeable

item with the potential hedging derivative.

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Module 21: Governmental (State and Local) Accounting


c. Regression analysis method—evaluates effectiveness by examining the statistical relationship

between the hedgeable item and the potential hedging derivative instrument.

If in a subsequent period the derivative is determined to be no longer effective, it is terminated as a

hedge and the balance in the deferral account should be reported in the flow of resources statement within

the investment revenue classification. GASB No. 64 amends GASB No. 53 to clarify whether an effective

hedge of a financial instrument can be maintained after the replacement of the swap counterparty or the swap

counterparty’s credit support provider. GASB No. 64 indicates that a hedging relationship is maintained

and hedge accounting should continue if there are no changes in terms or risk of the instrument other than a

replacement of the counterparty or the counterparty’s credit support provider.


Accounting for pollution remediation obligations. GASB Statement No. 49, Accounting and Financial

Reporting for Pollution Remediation Obligations, establishes rules for accounting for estimated obligations for

pollution remediation. A government must estimate its expected outlays for pollution remediation if it knows a

site is polluted and any of the following recognition triggers occur:

• Pollution poses an imminent danger to the public or environment and the government has little or no

discretion to avoid fixing the problem.

• The government has violated a pollution prevention-related permit or license.

• A regulator (e.g., the EPA) has identified the government as responsible or potentially responsible for

cleaning up pollution or paying some of the cost of the cleanup.

• The government is named in a lawsuit to compel it to address the pollution.

• The government begins or legally obligates itself to begin cleanup or post-cleanup activities.

Liabilities and expenses are estimated using an “expected cash flows” measurement technique.


Service concession arrangements. A service concession arrangement is an agreement between a government

unit and an operator in which

a. The government unit conveys to the operator the right and obligation to provide public services through the

operation of a facility (capital asset) in exchange for consideration;

b. The operator collects and is compensated by fees from third parties;

c. The government unit has the ability to modify or approve the services to be provided, to whom the operator

is required to provide the services, and the price of the services; and

d. The government unit is entitled to significant residual interest in the facility at the end of the arrangement.

Common examples of service concession arrangements include

1. Arrangements in which an operator agrees to design and build or improve a facility and collect fees

from third parties (e.g., construct a municipal complex or a tollway).

2. Arrangements in which an operator will pay the government unit for the right to operate a government

facility (e.g., a parking structure) and collect fees from third party for its use.

If the facility associated with the arrangement is an existing facility, the government unit should continue

to report the facility as a capital asset. If the facility is purchased, constructed or improved by the operator, the

government unit should record (a) the new facility (capital asset) at its fair value when it is placed in operation,

(b) any related contractual obligations as liabilities, and (c) a corresponding deferred inflow of resources equal

to the difference. A contractual obligation is one that is significant and related to the facility (e.g., an obligation


A state government through its Department of Transportation (DOT) enters into an agreement with the Local Tunnel

Authority (LTA), a governmental operator, in which LTA agrees to design, build and operate a tunnel for 40 years. In

exchange for building the tunnel, the LTA is entitled to collect and retain tolls generated by the tunnel for the term of

the agreement. The cost of the tunnel is $1 billion. The fair value of the tunnel when it is placed in operation is $1.5

billion. When the tunnel is placed in operation, the state government would record the asset at its $1.5 billion fair

value, and record $1.5 billion in deferred (revenue) inflow of resources.

In future years, the state government would apply existing capital asset guidance, including depreciation, if applicable, to the tunnel. If the state elects to use the straight-line method of amortization of revenue, it would recognize

$37,500,000 ($1.5 billion ÷ 40 years) in revenue for the next 40 years and reduce the deferred inflow by the same amount.

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Module 21: Governmental (State and Local) Accounting


by the government unit to provide insurance for the facility). These obligations should be measured at their

present values.

In the Notes to the financial statements, the government should disclose

1. A general description of the arrangement, including the government’s objectives for entering into the


2. Nature of amounts of assets, liabilities, and deferred outflows and inflows of resources related to the


3. Nature and extent of rights retained by the government.

4. The details of any related guarantees and commitments.


Related-party transactions. State and local governments must disclose certain related-party transactions.

In addition, if the substance of a particular transaction is significantly different from its form because of the

involvement of related parties, financial statements should recognize the substance of the transaction rather

than merely its legal form.


Subsequent events The requirements regarding the effect of subsequent events on financial statements are

similar to those for commercial businesses under GAAP. If the event provides additional evidence about

conditions that existed at the date of the statement of net position and affect the estimates in the financial

statements, the effect of the event should be recognized in the financial statements. If the event provides

evidence about conditions that did not exist at the date of the statement of net position but arose subsequent to

that date, the event should be disclosed in the notes to the financial statements.


Going concern considerations. The guidance regarding going concern for state and local governments is

similar to that for commercial business under GAAP. The financial reporting model assumes that the entity

will be a going concern for a reasonable period of time (i.e., 12 months from the financial statement date).

Indicators that there may be substantial doubt about the entity’s ability to continue as a going concern include





Negative trends (e.g., recurring losses).

Other indicators of financial difficulties (e.g., defaults on loan agreements).

Internal matters (e.g., work stoppages).

External matters (e.g., legal proceedings).

If it is determined that there is substantial doubt about a governmental entity’s ability to continue as a going

concern for a reasonable period of time, the notes to the financial statements should disclose details of the

sources of the concerns and the government official’s plan for dealing with those concerns.

GASB Statement No. 58, Accounting and Financial Reporting for Chapter 9 Bankruptcies, provides

accounting and financial reporting guidance when a governmental unit has been granted relief under the

provisions of Chapter 9 of the US Bankruptcy Code. The standard provides that assets and liabilities should be

remeasured in accordance with the court’s Plan of Adjustment. In addition, the statement requires disclosure of

the details of the bankruptcy and how users can obtain a copy of the Plan of Adjustment.


Financial Instruments Reporting. In June 2010 the GASB issued Statement No. 59, Financial Instruments

Omnibus, which updated and improved existing standards regarding reporting and disclosure requirements of

certain financial instruments and external investment pools. The specific issues related to financial instruments

addressed by GASB Statement No. 59 include

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a. Amended NCGA Statement 4 to be consistent with GASB Statement No. 53 regarding the guarantees of the

indebtedness of others.

b. Amended GASB Statements Nos. 25 and 43 to be consistent with the provisions of GASB Statement No.

31. The amendment removed the fair value exemption for unallocated insurance contracts. The effect is to

report investments in unallocated insurance contracts as interest-earning investment contracts.

c. Clarified GASB Statement No. 31 by indicating the 2a7-like investment pool is an external investment

pool that operates in conformity with Security and Exchange (SEC) Rule 2a7 as promulgated under the

Investment Company Act of 1940.

d. Amended GASB Statement No. 40 to indicate that interest-rate risk information should be disclosed only

for debt investment pools that do not meet the requirements to be reported as a 2a7-like pool.

e. Amended GASB Statement No. 53 as follows:

(1) A penalty payment for nonperformance that is dependent on the failure of the counterparty to comply

with the terms of construction or purchase contract does not meet the net settlement characteristic

included in the definition of a derivative instrument.

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Module 21: Governmental (State and Local) Accounting


(2) To be included with the scope of GASB Statement No. 53 a financial guarantee contract must meet the

definitions of a derivative instrument and be entered into primarily for the purpose of obtaining income

or profit.

(3) The scope of GASB Statement No. 53 excludes contracts that are not exchange-traded and have

reference rates based on specific volumes of sales or service revenue of one of the parties to the


(4) Provides that a hybrid instrument should be reported according to GASB Statement No. 53 if the

investor’s initial rate of return on the companion instrument has the potential for at least a doubled yield.


Government Combinations. Accounting for government combinations, including mergers, acquisitions,

and transfers of operations is covered by GASB No. 69. To be considered a government combination,

an arrangement should result in the continuation of a substantial portion of the services provided by the

previously separate entities.

a.A merger is a government combination of legally separate entities in which no significant consideration

is exchanged. In a merger, the new or existing entity recognizes the assets, deferred outflows of

resources, liabilities, or deferred inflows of resources in accordance with the accounting principles

applied in the most recent financial statements of the merged entities. In addition, these items are

generally measured at the carrying values of the separate entities. However, the items may be adjusted

to bring the accounting principles in alignment. Any capital assets that will be used in operations but

will be disposed of should be tested for impairment.

b.A acquisition is a government combination in which a government acquires another entity, or the

operations of another entity, in exchange for significant consideration. In an acquisition, the acquiring

entity recognizes the assets, deferred outflows of resources, liabilities, or deferred inflows of resources

in accordance with existing authoritative standards for state and local governments, and generally

measures the items at acquisition value at the date of the acquisition. However, acquired deferred

outflows of resources (or goodwill) arising from prior acquisitions should not be recognized by the

acquiring entity. Any capital assets that will be used in operations but will be disposed of should be

tested for impairment. In circumstances in which the consideration provided exceeds the net position

acquired, the acquiring entity should report the difference as a deferred outflow of resources which is

amortized based on a consideration of service lives of the acquired items. In circumstances in which the

consideration provided is less than the net position acquired, the acquiring entity should first reduce the

value assigned to noncurrent assets other than financial assets. If this reduces the noncurrent assets to

zero, any access should be recognized as a special item in the flows statements. Acquisition costs should

be recognized expenses/expenditures when they are incurred.

c.A transfer of operations is a government combination involving the transfer of operations of a

government or nongovernmental entity in which no significant consideration is exchanged. In a transfer

of operations, the continuing entity recognizes the assets, deferred outflows of resources, liabilities,

or deferred inflows of resources in accordance with the accounting principles currently applied. In

addition, these items are generally measured at the carrying values at the date of transfer. However, the

items may be adjusted to reflect authoritative standards, or bring the accounting principles in alignment

with those of the continuing entity. Any capital assets that will be used in operations but will be

disposed of should be tested for impairment.


Disposal of Operations. A disposing government should recognize a gain or loss on disposal of operations.

The disposal of operations should be reported as a special item in the statement of revenues, expenditures,

and changes in fund balances in the period in which the disposal occurs.


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L. Budgetary Accounting for the General and Special Revenue Funds

The GASB, in one of its basic principles, states

1. An annual budget(s) should be adopted by every governmental unit.

2. The accounting system should provide the basis for appropriate budgetary control.

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Module 21: Governmental (State and Local) Accounting

3. A common terminology and classification should be used consistently throughout the budget, the accounts, and

the financial reports of each fund.

In accordance with the principle above, budgets should be prepared for each of the fund types used by

governmental units. This directive, by itself, does not differentiate governmental from commercial enterprises.

What is different, however, is the inclusion of budgetary accounts in the formal accounting system for the

general and major special revenue funds. Inclusion of the budgetary accounts facilitates a budget-actual

comparison in Required Supplementary Information (RSI) or as a basic financial statement. The budget-actual

comparison is required for the general fund and all major special revenue funds that have a legally adopted

annual budget. Budgetary accounts are generally used in those funds for which the budget-actual comparison

is made. As a result, CPA examination questions always assume budgetary accounts for the general fund and

sometimes, but not always, assume budgetary accounts for special revenue funds.

Budgetary accounts (Estimated Revenues, Appropriations, Estimated Other Financing Sources, Estimated

Other Financing Uses, and Budgetary Fund Balance) are incorporated into governmental accounting systems

to provide legislative control over revenues and other resource inflows and expenditures and other resource

outflows. Recording the budget also provides an assessment of management’s stewardship by facilitating a

comparison of budget vs. actual. The journal entries that follow illustrate the budgetary accounts used by the

general and special revenue funds.

Upon adoption of the estimated revenues and appropriations included in the legally adopted budget (at the

beginning of the period), the following entry is made and posted to the general ledger:

Estimated Revenues2 (individual items are posted to

subsidiary ledger)

Appropriations (individual items are posted to

subsidiary ledger)

Budgetary Fund Balance

1,000,000 (anticipated resources/revenues)

980,000 (anticipated expenditures/liabilities)

20,000 (a surplus is anticipated since estimated revenues are

more the appropriations)

Estimated Revenues, Appropriations, and Budgetary Fund Balance are budgetary accounts. This budgetary

entry is reversed at year-end during the closing process.

As actual resource inflows and outflows occur during the year, they are recorded in Revenues and Expenditures

accounts, and the detail is posted to the revenues and expenditures subsidiary ledgers to facilitate budget vs. actual

comparisons. To prevent the overspending of appropriations (which is the legal authority to spend resources) an

additional budgetary account is maintained during the year. This budgetary account is called Encumbrances. When

goods or services are ordered, encumbrances are recorded so that appropriations are not overspent. The following

entry is used to record encumbrances:

Encumbrances (detail posted to subsidiary ledger)

Reserved for Encumbrances

5,000 (cost estimate)

5,000 (cost estimate)

The Reserved for Encumbrances is a fund equity account that is used to segregate the amount of encumbrances

outstanding. When the debit in the entry is posted, the amount that can still be obligated or expended for

an individual budget line item is reduced. Thereafter, when the goods or services ordered are received, the

encumbrance entry is reversed and the actual resource outflow (expenditures) is recorded.

Reserved for Encumbrances

Encumbrances (detail posted to subsidiary ledger)

Expenditures (detail posted to subsidiary ledger)

Vouchers Payable



5,200 (actual cost)

5,200 (actual cost)

The encumbrances account does not represent an expenditure; it is a budgetary account which represents

the estimated cost of goods or services which have yet to be received. In effect, the recording of encumbrances

represents the recording of executory contracts, which is essential to prevent overspending of an appropriation,

which is the legal authority to spend resources). As noted above, the account reserved for encumbrances is a fund

equity account, not a liability account. If encumbrances are outstanding at the end of a period, the encumbrances

Appropriations, estimated revenues, encumbrances, revenues, expenditures, estimated other financing sources, estimated other

financing uses, other financing sources, and other financing uses are “Control” accounts which require detail be posted to a subsidiary



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