1. Business-Type Activities
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Business-Type Activities
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2. Learning Objectives
Why governments and NFPs engage in business-type activities
Distinguish between Proprietary and Governmental activities
Fundamental principles of Proprietary Fund Accounting
Enterprise Funds
Internal Service Funds
Accounting for Insurance Activities
GASB 34, special problems of reporting proprietary funds in government-wide statements
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3. Proprietary Funds Reasons for use
-To compare benefits and costs of the
business-type activities of a government.
-Enhances management of activities
in which goods or services are
provided on a cost-reimbursement basis
to departments of the same government
or to the general public on a user charge basis.
Example: the city of Houston maintains two different types of proprietary funds.
-Enterprise funds and Internal Service funds
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4. Proprietary Funds Two types of funds are classified as proprietary:
Internal service funds:
-Provide services to other government departments on a user charge basis.
-Example: City of Houston Health Benefit and Long-term Disability funds.
Enterprise funds:
-Provide services to the general public on a user charge basis.
-Example: City of Houston’s Airports (Bush, Hobby and Ellington Field), George R. Brown Convention Center, etc.
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5. Proprietary Funds Accounting Characteristics
Governments:
-Full accrual basis
-Recognize revenues as earned and expenses as incurred.
-Balance sheet recognition to both capital assts and long-term debt.
Not-for-profits:
-Capital assets and long-term liabilities accounted for within the funds.
-Resources are donor-restricted and classified per FASB Statement No. 117
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6. Business-Type Vs. Governmental Activities
Business-type accounting used to account for proprietary funds:
Full accrual basis
Measurement focus on all economic resources is consistent with GASB
Information on depreciation
Facilitates comparisons with private enterprises
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7. Proprietary Funds Required Financial Statements
Similar to those for a for-profit entity:
Statement of Net Assets (or Balance Sheet): -Invested in capital assets, net of related debt -Restricted Net assets -Unrestricted Net Assets
Statement of Revenues, Expenses, and changes in Fund Net Assets: -comparable to income statement of a business -Reconciles beginning and ending net assets
Statement of Cash Flows:
-Required for proprietary funds but not
governmental funds
-Summarizes the entity’s cash account
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8. Statement of Cash Flows
FASB Statement No. 95 classifies cash transactions into:
Cash flows from operating activities
Cash flows from financing activities
Cash flows from investing activities
This is not applicable to governments.
GASB Statement No. 9:
Cash flows from non capital financing activities
Cash flows from capital and related financing activities
GASB mandates that governments report their cash flows using direct method: explicitly reports the operating cash flows
Indirect method: reconciles operating cash flows to operating income.
FASB encourages business and non-profits to use direct method.
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9. Proprietary Funds Accounting Equation
Assets = Liabilities + Net Assets
Recall this is the same classification of net assets that is required under GASB 34.
Unrestricted
Restricted
(e.g., for payment of
debt service)
Invested in Capital Assets, Net of Related Debt
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10. Enterprise Funds
Enterprise funds are used to report the same functions
presented as business-type activities in the
government-wide financial statements.
Reasons for use
Used to
-Account for services provided to the general public on a user charge basis or where the governing body has determined that periodic determination of revenues earned, expenses incurred, and/or net income is appropriate
-For capital maintenance, public policy, management control, accountability, or other purposes
The City of Houston uses enterprise funds to account for its aviation system, combined utility system (formerly called the water and sewer system), and the convention and entertainment facilities.
Enterprise Funds
Enterprise funds are established to account for City operations that are financed and operated in a manner similar to private business enterprises where the cost of providing goods or services to the general public is financed primarily through user charges.
Airport System — This fund is used to account for the operations of the City’s Airport System. The system is comprised of George Bush Intercontinental Airport, William P. Hobby Airport and Ellington Field.
Convention and Entertainment Facilities — This fund is used to account for the operation of the City’s four major entertainment centers and two City-owned parking garages. These centers include the following: Jesse H. Jones Hall; Bayou Place; Gus S. Wortham Center; George R. Brown Convention Center and the Tranquility Park and Theater District parking garages.
Combined Utility System — This fund is used to account for the production and transmission of water and the treatment of wastewater for City residents and businesses as well as for other governmental entities located in the Houston area.
Nonmajor Enterprise Funds – The Houston Area Water Corporation fund did not meet the established criteria for major fund status. The Houston Area Water Corporation was organized to provide water to the City of Houston for resale to customers located wholly or partially in Area Three of the Harris-Galveston Coastal Subsidence District.
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11. Common Types of Enterprise Funds
Water and sewer (public utilities)
Gas and electric utilities
Transportation systems
Airports (Bush, Hobby, Ellington Field)
Ports (Port of Houston)
Toll roads and bridges (Sam Houston Tollway – Beltway 8)
Parking garages and lots (Theater District parking garage)
Golf courses (Hermann Park)
Hospitals (Ben Taub)
Liquor stores.
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12. Accounting for Enterprise Funds
GASB Statement No. 34 provides guidance on business-type activities:
Use of enterprise funds when one of the following criteria is met:
Activity financed solely with revenue debt instead of governmental obligation debt.
Costs of providing services recovered by fees and charges
Pricing policy establishes fees and charges to recover costs
Previously, GASB standards allowed proprietary funds two options:
Follow pronouncements of the FASB and its predecessors issued before November 30, 1989, unless they conflict with a GASB standard
Follow all FASB and predecessor standards, both those issued before and after November 30, 1989, unless they conflict with a GASB standard
Note that GASB standards always take priority
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13. Enterprise Funds – Restricted Assets
Definition: Assets whose use is restricted by contractual agreements or legal requirements
Typical examples:
Customer deposits of utilities, assets set aside for repayment of revenue bond principal, reserves for maintenance of plant, and funding of depreciation
Ideally liabilities to be paid from restricted assets should be reported separately from liabilities to be paid from unrestricted assets.
Net Assets - Restricted assets should be reported in the Equity section of the Statement of Net Assets.
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14. Enterprise Funds Utility Plant - Construction in Progress
Q: Should interest incurred on debt during construction be capitalized?
A: Yes.
Q: Should an imputed amount equivalent to interest be capitalized if a utility’s own funds are used for construction?
A: Capitalizing an “equity” component of Allowance for Funds Used During Construction (AFUDC) is permitted both by utility regulators and the FASB.
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15. Enterprise Funds Special Current Liabilities
In addition to the usual Accounts Payable and Accrued Expenses, use two special current liability accounts:
Customers Advances for Construction
Usually up-front deposits required to be made by builders to provide all or part of the cost of connecting new structures to utility lines. May or may not be refunded in part upon completion
Customer Deposits
Usually reported under the caption “Liabilities Payable from Restricted Assets”
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16. Enterprise Funds Regulatory Accounting Principles (RAP)
Key RAP definitions
Original cost: The (depreciated) cost to the first owner to place the utility plant into public use
Utility Plant Acquisition Adjustment: The difference between the purchase price of a utility plant less the net original cost of the plant on the seller’s books.
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17. Municipal Solid Waste Landfills
Accounted for either in governmental or enterprise funds
If usage fees are charged—accounted for in enterprise funds.
Governments have to report both -- expense and liability.
Liability of post closure costs reported only in government-wide.
“Pay-as-you-go” basis
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18. Municipal Solid Waste Landfills (cont’d)
An EPA rule requires all municipal landfills to meet stringent location, design, and operating requirements to minimize the potential for environmental damage.
Operators must also provide financial assurance they can properly close landfills when full and provide post-closure ground water monitoring for 30 years after closure.
These stringent rules are designed to protect the environment from irresponsible handling of hazardous materials
Estimate the current cost of hiring a qualified third-party to close the MSWLF and care for it for 30 years after closure
Recognize a portion of this cost proportionate to the ratio of estimated capacity utilized during a year over the total capacity of the landfill as an expense of the enterprise fund and as a liability
Annual adjustments are made as estimates change from year to year.
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19. Enterprise Funds Segment Information
When there are multiple enterprise funds
Summary operating data, including extent of intra- governmental subsidies, should be disclosed in the notes for "major non-homogeneous enterprise funds."
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20. Internal Service Funds
Used to account for services provided by governmental units to other governments on a cost reimbursement basis.
These funds are accounting entities.
Promotes efficiency
Usually accounted for in general fund or some governmental fund
Authorized by legislative approval
ISF resources are rarely restricted.
Accounted for in general fund or other governmental fund.
Reasons for use: Improve management of common resources by placing them under centralized management and control
The City of Houston uses internal service funds to account for health and benefits and long-term disability activities.
Because both of these services predominantly benefit governmental rather than business-type functions, they have been included within governmental activities in the government-wide financial statements.
Internal Service Funds
Internal service funds are used to account for the financing of goods or
services provided by one city department to other city departments on a cost
reimbursement basis.
Health Benefits — This fund is used to account for the costs incurred to
provide City employees’ health care and life insurance benefits.
Long-Term Disability — This fund is used to account for the costs incurred
to provide City employees long-term disability coverage.
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21. Accounting for Internal Service Funds
Revenues recognized when earned.
Expenses recognized on full accrual basis.
Derives revenues mainly from other governmental or proprietary funds.
Accounting for both ISF & enterprise funds: must follow all FASB pronouncements issued prior to Nov. 30th 1989 unless it conflicts with GASB pronouncement.
Generally should use the same accounting procedures that a similar for-profit entity would use. Billings to Departments is the revenue account that is similar to Sales of a for-profit entity
Revenues and expenses are closed at year-end to Excess of Net Billings to Departments over Costs (or Excess of Costs over Net Billings to Departments) rather than to Income Summary
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22. Common Types of Internal Service Funds
Motor pools
Central purchasing
Storage
Issuance of supplies
Self-insurance pools
Central data processing
Printing
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23. Internal Service Funds Financial Statements
Other than the slight difference in terminology, the financial statements are essentially the same as those of a comparable for-profit entity.
Statement of Net Assets
Statement of Revenues, Expenses, and Changes in Net Assets
Statement of Cash Flows - prepared in conformity with GASB standards rather than FASB standards.
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24. Internal Service Funds Statement of Cash Flows
Similarities between GASB and FASB standards:
Cash Flows Statement shows cash inflows/outflows relating to operating, financing, and investing activities
Both sets of standards define cash flows as cash and cash equivalents (i.e., time deposits, marketable securities, and other items readily convertible to cash)
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25. Internal Service Fund—Illustration
Q: Assume that one of the government’s internal service funds was for data processing services, for which the golf course was billed $30,000, all of which was classified as “contractual services” in the golf course fund. How would that amount be reported in the column for ISF? How would it be reported in the government-wide financial statements?
A: Fund Statements: Billings of ISF would be reported as a revenue of ISF and as an expense of the golf course. The related cost of providing the service would be reported as an expense of the ISF.
Government-wide: Billings would be reported ONLY as an expense of the golf course. The revenues and expenses of the ISF would be eliminated in the consolidation process.
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26. Internal Service Funds Capital Assets and Depreciation
Depreciation of capital assets acquired by contributions or grants.
The issue is: should the ISF be able to recover in its prices or rates a cost it did not incur for such assets?
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27. ISF Illustration
Q: ISF reported $2.7 million in depreciation, an amount that the government takes into account in establishing the rates charged to other funds. How would this charge be reflected in the government-wide statements?
A: The depreciation charges are incorporated into the amounts billed to the funds to which the ISF provide services. Therefore, in the government-wide, they would be incorporated into the expenses of the functions accounted for in those funds.
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28. ISF Example
Q: In which column on the government-wide statement of net assets—that for governmental or business-type activities—is it most likely that the assets and liabilities of the ISF would be included?
A: Unless the ISF provide services mainly to units accounted for in proprietary funds, their assets and liabilities would be reported in the column for governmental-type activities.
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29. Pricing Policies for Internal Service Funds
Pricing is set by local management or by legislative policy
Pricing objectives vary
Can cover full costs (direct and indirect), direct costs only, or whatever management desires.
Full cost prices do not reflect cost of providing incremental amounts of goods or services.
Legislative bodies are sometimes reluctant to establish ISFs because they are do not wish to let purchasing occur outside the budget.
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30. Internal Service Funds (cont’d)
Q: Is this a real concern?
Even if an ISF is created for central purchasing and sales of supplies, the legislative body still maintains budgetary control over the expenditures made by most departments and programs via the General Fund and special revenues funds budgets.
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31. Internal Service Funds
GASB-mandated use of an ISF
GASB standards require that an ISF be used for risk management (self-insurance) pools of a government:
The ISF should recognize claims expense and a related liability when:
it is probable that an asset has been impaired or a liability has been incurred and the amount is reasonably estimable, or
if an estimable loss has been incurred and it is probable that a claim will be asserted
Disclose other loss contingencies in the notes.
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32. ISF Accounting Procedures
Critical Implications:
Duplicate reported expenses:
costs and revenues are reported twice within the same set of financial statements.
Transfer of depreciation to governmental funds
Detract from Objectivity of Financial Statements
Obscure Fund Balance Surpluses or Deficits:
surpluses/deficits can be transferred from general fund to the internal service fund.
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33. Terminating an Internal Service Fund
Transfer ISF's assets to another fund which will continue same activity
Terminate activity and distribute assets in-kind to another fund or funds
Convert ISF's assets to cash and distribute cash to another fund or funds
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34. Self-Insurance Governments elect to self-insure their risks
Reduces portion of the premium
Accounted for in either general fund or ISF.
Insurance department acts as an independent insurance company.
Self insurance is no insurance: no transfer of risks to outsider.
It simply sets aside funds to provide for possible losses.
Payments for self-insurance premiums:
Only portion of the premium is reported as expenditure—this amount is recognized as revenue in ISF.
Excess is treated as a nonreciprocal transfer.
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35. Business –Type Activities Summary
Proprietary funds (internal service and enterprise) are used to account for the business-type activities of a government
Accrual accounting is used for proprietary funds and the required financial statements are the same as those for a for-profit entity, except that GASB standards must be used where they apply
ISF are reported as governmental activities on the government-wide statements
Regulatory accounting terminology and principles are used by some government owned utilities.
END
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