Lecture 10: Accounting and Financial Condition

1. Lecture 10: Accounting and Financial Condition EDA 757/PPA 730 Fall 2002

2. Lecture 10 Outline • Overview • Financial statements—pre-GASB 34. • GASB 34—Overall financial statements • Using financial statements to assess fiscal health.

3. Good Sources of Information on Accounting and GASB 34 • GASB Statement No. 34: Implementation Recommendations of School Districts. ASBO International, 2000. • Dean Michael Mead. What You Should Know About Your School District’s Finances. GASB, 2000. • SED. Reference Manual for Audits of General Purpose Financial Statements of New York State School Districts. SED, 2002. http://www.emsc.nysed.gov/mgtserv/for_those_districts_implementing%20GASB34%20.htm • GASB. Guide to Implementation of GASB Statement 34 on Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments. GASB, 2000.

4. Overview of Government Accounting • Financial management requires a common language, so that all parts of the government can be compared--that language is the governmental accounting system. It is the set of definitions and rules which guide the collection, categorization and reporting of financial data. • The language of accounting can differ across organizations, but it can be difficult without training to detect the difference. • It is important to understand the different types of accounting systems, their objectives, how data is recorded, and what financial information tells you about the organization’s finances.

5. Fundamental Equation of Accounting • Assets = Liabilities + Fund Balance • Assets – Liabilities = Fund Balance • Change in Assets = Change in Liabilities + Revenues – Expenditures.

6. Accounting--Definitions • Assets: What government owns. • Current assets: Assets that can be liquidated this year. • Cash • Short-term investments • Accounts (and taxes and grants) receivable • Inventories. • Non-current assets: Assets that are more permanent in nature. • Capital assets not to be depreciated—land, facilities under construction. • Capital assets that have depreciated: facilities, equipment. • Long-term financial investments.

7. Accounting--Definitions • Liabilities: What government owes. • Current liabilities: will come due this year. • Accounts payable • Deferred revenue • Short-term debt (BANs, TANs, RANS) • Due other funds or governments. • Non-current liabilities: • Long-term debt • Compensated absences • Post-employment benefits • Due retirement systems • Judgments and claims payable

8. Accounting--Definitions • Fund balance (net assets): Defined as the difference between assets and liabilities. Can be divided into: • Reserves for encumbrances • Other reserves (e.g., capital, repair, Worker’s Compensation, Unemployment Insurance, debt service, insurance, etc.) • Unrestricted, unreserved fund balance, which is available for any purpose.

9. Accounting--Definitions • Revenues: • Property taxes • Other taxes • Charges for services • State revenues • Federal revenues. • One-time sales

10. Accounting--Definitions • Expenditures (expenses): By function. • General support • Instruction • Pupil transportation • Community service • Employee benefits • Debt service • Capital outlay (depreciation) • Cost of Sales

11. Expenditure Classification (accounting codes) • NCES classification system: • Fund (1 digit) • Year (2 digits) • Function (4 digits) • Program (3 digits) • Object (3 digits) • Cost center (3 digits)—usually school. Example: 1 99 1000 100 610 105

12. Expenditure Classification (New York) • New York uses a different classification system (ST3 form): • Fund: (1 digit), A=general, B=school store, C=food service, F=special aid fund, H=capital projects, V=debt service. • Function (4 digit): 1000=general support, 2000=instruction, 5000=transportation, 7000=community services, 8000=civic activities, 9000=undistributed expenditures. • Object (2 digits): .1=salaries, .2=equipment, .4=contractual, .45=materials and supplies, .49=BOCES, etc. • Example: A2010.15 General fund, instruction, supervision, instructional salaries. ST3 is available at: http://stateaid.nysed.gov/st3_info.htm

13. Revenue Classification(accounting codes) • New York system is very similar to NCES. • Fund (1 digit): same as expenditures • Source (4 digits): 1000=local sources, 2000=revenue from other local governments, or from sales of property (overlaps with 1000), 3000=state aid, 4000=federal aid, 5000=other sources (interfund transfers). • Example: A1001 General fund, real property taxes (excludes STAR revenue).

14. Measurement Focus • The definition of what should be measured is called the measurement focus, and the issue of when transactions are recorded in the accounting system is the basis of accounting. • Accrual (business) accounting: Objective is to preserve equity of the investors, which accountants refer to as a economic resource measurement focus. • Modified accrual accounting: Objective is to assure financial control or accountability for general government functions, which implies a measurement focus on current financial resources.

15. Basis of Accounting • Accrual: • Assets and liabilities: Under accrual accounting it is important to report all assets and liabilities on the balance sheet. This implies that even long-term assets, such as buildings and equipment, should be added when acquired and long-term liabilities, such as debt, pension obligations, etc., should be reported as they are incurred (see Figure 10-1) • Receipts and expenses: Receipts are recognized and recorded when they have been earned regardless of whether payment has been received. Accrual accounting recognizes expenses or the monetary value of resources used during the period to produce revenues when the resources have been used regardless of when the resources are paid for (Figure 10-1).

16. Basis of Accounting • Modified Accrual: • Assets and liabilities: focus on those assets and liabilities, which tend to be short-term in nature. This implies that modified accrual accounting focuses on current assets and current liabilities. (Figure 10-1). • Revenues and expenditures:Revenues are recorded only when they are measurable and available. This implies for many taxes, such as the sales and income tax that they are recorded only when the cash is received. The term expenditures reflects commitments to pay for purchases of goods and services with current financial resources, not when resources are used. Therefore, the modified accrual basis is more conservative in its recording of revenues and expenditures (Figure 10-1).

17. FIGURE 10-1 COMPARISON OF THE BASES OF ACCOUNTING (1) (2) Accrual Basis Modified Accrual Basis A. Revenues and recorded when: Measurable (the amount Measurable (the amount can be determined) and can be determined) and Earned (the service has Available (the revenue was been provided) collected in the current fiscal year or will be collected soon enough after the close of the fiscal year to pay liabilities of the current year) B. Expenses/expenditures are (Expenses) (Expenditures) Measurable (the amount Measurable (the amount can be determined) and can be determined) and Incurred (the liability Incurred (the liability has has been created) been created and will be paid from current resources) C. Fixed assets are reported as: Assets in the fund Expenditures where the purchase in the fund where the purchase is made and in the is made statement of net assets D. Depreciation is reported: As an expense in the Not recorded fund owning the fixed asset and in the statement of activities E. The issuance of debt is As a liability in the fund As an “other financing source” reported: where the debt is issued on the operating statement. F. The repayment of debt is As a reduction of the As an operating expenditure. reported: liability G. Measurement focus used: Economic resources Current financial resources

18. Fund Accounting • A crucial difference between public and private sector accounting is in the use of multiple funds in the public sector. Funds are separate fiscal and accounting entities used to record assets, liabilities, revenues and expenditures/expenses associated with certain government functions. • Three types of funds: • Governmental funds: Used to record finances of general government operations. • Proprietary funds: Used to record finances of government “business” operations. • Fiduciary funds: Report assets that are held for others and that cannot be used to support the government’s own programs.

19. Governmental Funds • a) General fund: The largest single fund in most governments is the "general fund". As the name implies this is fund used to account for all revenues, expenditures, assets and liabilities not required to be reported somewhere else. Most general revenue sources go directly into the general fund and most of the current operations of government departments are recorded in this fund. In addition, there is a great deal of transfers between other governmental funds and the general fund. • b) Special revenue fund: This is a fund used to account for special revenue sources which are earmarked for use for specific purposes. The most common in New York is a “special aid” fund that records transactions associated with categorical state and federal grants. • c) Capital projects fund: This is used to account for the construction of capital projects to be used for general government operation, not for a special revenue group or public enterprise. For example, the construction of school buildings would generally be recorded under this fund. It receives its revenues from debt recorded in the "debt service fund" or general revenue sources from the general fund. • d) Debt service fund: Is used to account for the long-term "general-obligation" debt committed by a community. In this fund would be recorded the payment of principal and interest. The revenues from these payments will generally come from the general fund. • e) Permanent fund: Is used to record a permanent endowment provided the government. The endowment itself is not to be spent. Instead, interest payments from the endowment may be used. * Accounting standard: Modified accrual.

20. Proprietary Funds • a) Enterprise funds: Are used to account for agencies of the government, which produce a self-financing service for external customers. Examples might include a fund for school lunch, school store, and transportation. Since this is supposed to emulate a private firm, these funds are generally self-contained, including all debt, and capital construction transactions. • b) Internal service fund: This is a parallel type of fund used to record transactions for a government agency which provides services to other government agencies. Examples might be a motor pool/repair department, computer support or a print shop. Other governments agencies are supposed to be charged the full cost of the service. * Accounting standard: Accrual.

21. Fiduciary Funds • Trust funds: are created to record resources the district is managing as a trustee. The district invests the funds, and may expend interest and principal. • Agency funds: are created when the district acts as an agent to manage resources for another group (e.g., student and parent organizations). *Accounting standard: Accrual.

22. FIGURE 10-2 FUND ORGANIZATIONAL CHART The Reporting Entity A. Governmental Fund Types 1. General 2. Special Revenue 3. Capital Projects 4. Debt Service 5. Permanent B. Proprietary Fund Types 6. Enterprise 7. Internal Service C. Fiduciary Fund Types Agency Employee Benefit Trust Investment Trust Private Purpose Trust

23. Financial Statements(Pre-GASB 34) • Balance sheet: Measures the assets and liabilities at a given point in time (last day of the fiscal year). • For governmental funds, only current assets and liabilities are recorded. • For proprietary funds (and long-term fixed asset account group) will include property, plant and equipment as assets, and long-term bonds and capital leases as liabilities (also in long-term obligations account group). Example of pre-GASB 34 CAFR for Cincinnati City School District: http://www.cpsboe.k12.oh.us/general/finances/2001CAFR.pdf

28. Financial Statements(Pre-GASB 34) • Statement of revenue, expenditures and changes in fund balance: Records flows over the course of the year: • Revenues (receipts): additions to fund balance. • Expenditures (expenses): subtractions from fund balance. • Fund balance at beginning of year and end of year: difference is the surplus or deficit in this fund. * “Totals (Memorandum only)” indicates that the sum of the three different types of funds should be viewed with caution, because of different accounting standards. Example of pre-GASB 34 CAFR for Cincinnati City School District: http://www.cpsboe.k12.oh.us/general/finances/2001CAFR.pdf

31. Changes Under GASB 34 • Management discussion and analysis section, which is meant to provide a user friendly introduction and summary to the CAFR. • Government-wide financial reporting using an accrual basis of accounting. Even financial data for “governmental funds,” which will continue to be reported using modified accrual accounting, will also be recast on an accrual basis so that picture of the financial position of the whole government can be determined. • Government-wide financial reports will record for the first time all long-term assets (equipment, land, building, other infrastructure), and liabilities (long-term debt). • Expenses that include consumption of capital assets (depreciation), rather than expenditures, which include the full cost of capital purchases in the year the purchases were made, will be reported on a government-wide basis. • Two new financial statements will be required—The Statement of Net Assets, and Statement of Activities (discussed below).

32. Comprehensive Annual Financial Report (CAFR) • Principal reporting of audited financial information to board of education, citizens, federal and state governments. • Organized into 5 sections: • Introduction: Transmittal letter of auditor, letter from independent auditor, organization of government, management discussion and analysis. • Government wide financial statements. • Combined financial statements by fund type. • Notes to financial statements (see below). • Supplementary material, and statistical information.

33. · — FIGURE 10-3 - THE FINANCIAL REPORTING “PYRAMID” (1) I NTRO. SEC., AUDITOR LETTER, MGT. DISCUSSION AND ANALYSIS THE COMPREHENSIVE (2) ANNUAL GOVERNMENT - WIDE FINANCIAL FINANCIAL STATEMENTS REPORT (CAFR) (NET ASSETS, ACTIVITIES) (3) COMBINED STATEMENTS BY FUND TYPE BALANCE SHEET, INCOME STATEMENT, CASH FLOWS (4) INDIVIDUAL FUND AND ACCOUNT GROUP STATEMENTS (5) SCHEDULES (6) TRANSACTION DATA (THE ACCOUNTING SYSTEM)

34. Government-wide Financial Statements • Statement of Net Assets: • Assets: current assets, capital assets (can’t be depreciated), capital assets that can be depreciated. Capital assets may be presented net of depreciation. • Liabilities: current liabilities, and long-term liabilities due this year (or after this year), which include long-term debt, funds due to pension systems, uncompensated absences, benefits (health care) due employees after retirement. • Net assets: Investment in capital assets net of related debt, restricted net assets, and unrestricted net assets. See categories recommended by SED, and example for New York City (total government, not just school district). Website for NYC CAFR: http://www.comptroller.nyc.gov/

35. Sample School District Statement of Net Assets June 30, 2002 ASSETS Cash Unrestricted Restricted Investments Unrestricted Restricted Receivables Taxes State and Federal aid Due from other governments Other Inventories Deferred expenditures Capital assets, net Total Assets

36. LIABILITIES Payables Accounts payable $ Accrued liabilities Due to other governments Bond interest and matured bonds Notes payable Tax anticipation Revenue anticipation Bond anticipation Deferred credits Overpayments and collections in advance Deferred revenues - planned balance Deferred revenues - other Long-term liabilities Due and payable within one year Bonds payable Installment purchase debt payable Due to teachers' retirement system Due to employees' retirement system Compensated absences payable Other postemployment benefits payable Judgments and claims payable Due and payable after one year Bonds payable Installment purchase debt payable Due to teachers' retirement system Due to employees' retirement system Compensated absences payable Other postemployment benefits payable Judgments and claims payable

37. NET ASSETS Investment in capital assets, net of related debt Restricted for: Encumbrances Capital Tax certiorari Workers' Comp., Unemployment & Insurance Employee benefit accrued liability Inventory Subsequent year's expenditures Unrestricted (deficit) Total Net Assets $ -

39. Government-wide Financial Statements • Statement of activities: is a major change from the previous statement of revenues and expenditures. Includes information on: • Expenses (costs) by program or function (e.g., instruction), and indirect expenses allocated to each function. Provides key information for cost analysis. • Revenues associated with a particular program or function including charges and fees, and operating and capital grants. • Net revenues by program. • General revenues, which fund multiple programs of the school district. • Changes in net assets, net assets at the beginning and end of the year.The difference between the net assets this year and last year is the surplus/deficit. See categories recommended by SED, and example for New York City (total government, not just school district).

41. GENERAL REVENUES Real property taxes Other tax items Nonproperty taxes Use of money and property Sale of property and compensation for loss Miscellaneous Interfund revenue State sources Federal sources Medicaid reimbursement Total General Revenues - Change in Net Assets - Total Net Assets - Beginning of year Total Net Assets - End of year $ -

43. Other Parts of CAFR • Consolidated financial statements by type of fund: These are very similar in form to what these statements would look like before GASB 34. • Governmental funds: modified accrual • Proprietary funds: accrual • Fiduciary funds: accrual

44. Other Parts of CAFR • Notes (GASB 34): • Note 1: Significant Accounting Policies—provides a description of the accounting system and some of the terminology. • Note 2: Reconciliation of governmental fund statements and district-wide statements. • Note 3: Changes in accounting principles. • Note 4: Stewardship and compliance with legal and contractual provisions. Discusses actions to correct problems. • Note 5: Cash in financial institutions • Note 6: Participation in BOCES. • Note 7: ST investments at fair market value by type of investment. • Note 8: Capital assets balance and activity during year. • Note 9: Related party transactions. • Note 10: Short-term debt by type. • Note 11: Long-term debt and lease-purchase obligations.

45. Other Parts of CAFR • Note 12: Interfund balances and activity. • Note 13: Pension funds. • Note 14: Post-employment benefits (primarily health care for retirees. • Note 15: Risk management practices. • Note 16: Fund balances and reserve funds. • Note 17: Excess of actual expenditures over budget (budget variance information). • Note 18: Donor restricted endowments. • Note 19: On-behalf-of payments (payments made to a 3rd party). • Note 20: Discretely presented component units (most districts won’t have this.) • Note 21: Subsequent events (capital projects committed this year but completed in future years.) • Note 22: Contingent liabilities: possible liability for returning grant funds. For a full list and description of notes see: “Reference Manual for Audits of General Purpose Financial Statements…” Appendix 3:http://www.emsc.nysed.gov/mgtserv/for_those_districts_implementing%20GASB34%20.htm

46. Other Parts of CAFR • Supplemental information: Optional but very important to financial analysis of district. • Revenues and expenditures for last 10 years. • Assessed and equalized value of property for 10 years. • Debt ratios—see Lecture 13. • Demographic statistics. • Principal taxpayers—helps to identify how diverse district revenue sources are. • Enrollment trends and projections. • Per pupil spending trends and comparison.

47. Using Financial Statements to Assess Fiscal Health • “Sound fiscal health is imperative to the effective operation of municipalities in New York State. For this reason, local managers should periodically assess the financial condition of their local government.” Office of the State Comptroller, 2002. • Audited financial statements provide one of the best sources of information to examine the financial condition of a government. • Determining financial condition can be complex, but there are some simple indicators that can provide visibility on the fiscal health of district.

48. Defining Financial Condition • “Financial condition may be defined as a local government’s ability to finance services on a continuing basis. This ability involves maintaining adequate service levels while surviving economic disruptions, being able to identify and adjust to long-term changes and anticipating future problems.” (NYS Comptroller, 1992, p. 1) • Adequate service levels imply providing adequate resources so that students have the opportunity to reach Regents standards.

49. Figure 10-4: Framework for Measuring Financial Condition Overall Evaluation LR Financial Service SR Financial Condition Condition Level Adequacy Fund Liquidity Surplus/Deficits Balance Dropout Regents Exams Other Exams Rates Economic Financial Financial Debt Ratios Measures Management Factors (based on survey)

50. Framework for Financial Condition Indicator System • Short-run financial condition: Ability to pay bills over the course of the year, balance the budget, and maintain adequate fund balance without extraordinary measures. Categories of indicators include: • Liquidity: Ability to pay bills. • Structural balance: Do revenues cover expenditures without use of fiscal gimmicks? • Fund balance: Does district have adequate reserves to cover financial emergencies?