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Financial Accounting for Local and State School Systems, 2003 Edition

Account Classification Description
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Table of Contents
Uses of Information
Governmental  Accounting
Financial Accounting
Cost Accounting and Reporting for Educational Programs
Activity Fund Guidelines
Summary of Account Code Changes and other Appendices
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Frank Johnson
(202) 502-7362

Chapter 5: Financial Reporting

Fund Balance/Net Assets

Fund Financial Statements

Within governmental funds, equity is reported as fund balance; proprietary and fiduciary fund equity is reported as net assets. Fund balance and net assets are the difference between fund assets and liabilities reflected on the balance sheet or statement of net assets. Because of the current financial resources measurement focus of governmental funds, fund balance is often considered a measure of available expendable financial resources. This is a particularly important measure in the general fund because it reflects the primary functions of the government and includes both state aid and local tax revenues. The relative amount of unreserved fund balance reflected in the general fund is used by rating agencies as a measure of financial strength of the government. Declines in the amount of unreserved fund balance may signal deterioration in the financial condition of the entity.

Governmental fund balances are categorized as follows:

  • Reserved
  • Unreserved
    • Designated
    • Undesignated
Reserved Fund Balances

Reservations of fund balance should be used in governmental financial reporting to identify the portion that is
  • not available for appropriation or expenditure (e.g., reserve for inventories, reserve for long-term receivables) and/or
  • legally earmarked by external parties or entities for a specific future use, that is, a legal restriction on the use of assets (e.g., reserve for encumbrances).
The amount and nature of the reservation of fund balance should be disclosed on the face of the financial statements. The description may need to be supplemented by disclosure in the notes to the financial statements.

Examples of reservations of fund balance follow:

  • Inventories
  • Debt service
  • Endowments
  • Prepaid items
  • Outstanding encumbrances
  • Construction
  • Federal and state programs
The aggregate fund balance in the debt service fund is legally reserved for the payment of bonded indebtedness and is not available for other purposes until all bonded indebtedness is liquidated. The fund balance of the capital projects fund reflects an amount designated for construction and major renovation projects, and it usually represents unexpended proceeds from the sale of bonds that have restricted uses. However, in all instances in which the name of the fund communicates the legal segregation, the fund balance should be reported as unreserved.

Unreserved Fund Balances

Unreserved fund balance is the difference between the total and reserved fund balance. It has two components: designated and undesignated. The unreserved fund balance of the general fund represents the balance available for legal appropriation and expenditure for general operating expenditures.

Prudent financial management requires accumulating a sufficient undesignated, unreserved fund balance in the general fund representing available expendable financial resources to meet the net cash outflows during the fiscal year.

Designated, Unreserved Fund Balances. Portions of fund balance may be designated by management to reflect tentative plans or commitments of governmental resources. Designations generally reflect board action to earmark the balance for purposes that will be fulfilled at a later time, but specific board action is not required. Designations represent planned actions, rather than actual commitments. Because they typically arise from internal actions (management decisions) rather than actions external to the entity (encumbrances), designations are reported as part of unreserved fund balance.

The amount and nature of the designation should be explained in a

  • separate line of the balance sheet,
  • parenthetical comment, or
  • note to the financial statements.
Designations may be related to
  • construction or other capital expenditures,
  • claims and judgments, or
  • self-insurance contingencies.
Undesignated, Unreserved Fund Balances. Undesignated, unreserved fund balance is the difference between total fund balance and the portion that is reserved and designated. This is the balance available for legal appropriation and expenditure if a government budgets on a GAAP basis for its governmental funds.

Within proprietary and fiduciary fund statements of net assets, net asset balances are classified into three components:

  • Invested in capital assets, net of related debt represents the net amount invested in capital assets (original cost, net of accumulated depreciation, and capital-related debt).
  • Restricted represents the amount of net assets for which limitations have been placed by creditors, grantors, contributors, laws, and regulations. For example, school districts that account for food services within an enterprise fund may have restrictions related to certain proceeds or commodities imposed by the USDA. Internal actions through enabling legislation and constitutional provisions may also lead to restricted net assets.
  • Unrestricted is the amount of net assets that is not restricted or invested in capital assets, net of related debt.
Governmentwide Financial Statements: Statement of Net Assets

The difference between an entity's assets and liabilities in the Statement of Net Assets represents its net assets. Net assets have three components:
  • Invested in capital assets, net of related debt
  • Restricted net assets
  • Unrestricted net assets
Table 3 defines each component.

Table 3. Net Asset Classification  
Invested in Capital Assets, Net of Related Debt Restricted Net Assets Unrestricted Net Assets

All capital assets (including restricted capital assets) net of accumulated depreciation and reduced by outstanding balances of debt relating to the acquisition, construction, or improvement of these assets

If the entity has capital assets but no related debt, the account should be titled "invested in capital assets" so that readers are not misled.

Net assets on which limitations have been placed by creditors, grantors, contributors, laws, and regulations of other governments.

Also, internal actions may lead to restricted net assets in some cases such as constitutional provisions or enabling legislation.

All other net assets not included in the "Invested in capital assets, net of related debt" category or the "Restricted net asset" category.

Internal designations may not be shown in this statement.

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The accounting and financial reporting for revenues within a governmental entity is determined by the economic substance of the underlying transactions. Generally accepted accounting principles have established criteria for recognition based on the classification and characteristics of the transaction.

Within governmental entities, transactions may be classified as either exchange (or exchange-like) transactions or nonexchange transactions. Exchange transactions are those in which the parties involved give up and receive essentially equal values. Within a commercial enterprise, transactions between businesses and their customers meet this definition. Within a proprietary fund of a governmental entity, fees or charges made for goods or services represent exchange transactions.

Although similar to exchange transactions, exchange-like transactions represent situations in which the values exchanged may not be equal or the direct benefits may not be exclusively for the parties involved in the transaction. Examples include permits and professional or regulatory licensing fees.

To clarify and expand existing guidance in the accounting and financial reporting of nonexchange transactions within governments, GASB issued Statement 33, Accounting and Financial Reporting for Nonexchange Transactions, and Statement 36, Recipient Reporting for Certain Shared Nonexchange Revenues (an amendment of Statement 33). These standards establish recognition criteria for nonexchange transactions reported on the accrual basis or the modified accrual basis of accounting.

Statement 33 describes four classifications of nonexchange transactions:

  • Derived tax revenues result from assessments imposed on exchange transactions, such as income taxes and sales taxes. Derived tax revenues and the related receivables normally should be recognized when the underlying transaction occurs with the criteria extended to include the availability criteria for revenues accounted for on the modified accrual basis.
  • Imposed nonexchange revenues result from assessments imposed on nongovernmental entities, other than assessments on exchange transactions. Property taxes, ad valorem taxes on personal property, and fines are common examples. A receivable is usually recognized at the time an enforceable legal claim arises. Imposed nonexchange revenues should be recognized in the first period in which the use of the revenues is permitted or required. For imposed nonexchange revenues accounted for on a modified accrual basis, recognition also depends on the availability of the resources.
  • Government-mandated nonexchange transactions occur when a government at one level provides resources to a government at another level and requires the recipient to use them for a specific purpose in accordance with the provider's enabling legislation. An example is the federal funds provided for food and nutrition programs in school districts.
  • Voluntary nonexchange transactions result from legislative or contractual agreements, other than exchanges, entered into willingly by two or more parties. Certain grants and entitlements and most donations are examples of this type of transaction. Frequently, purpose restrictions and eligibility requirements are established by the provider.
For both government-mandated nonexchange transactions and voluntary nonexchange transactions, revenues and receivables should be recognized when all eligibility requirements have been met. For revenues accounted for on a modified accrual basis, the criteria are extended to include the availability of the resources.

GASB Codification Section 1600.106 states that revenues in governmental funds and other governmental fund financial resource increments are recognized using the modified accrual basis of accounting when they are susceptible to accrual, which means they must be both measurable and available. Revenues are measurable when the amount of the revenue is subject to reasonable estimation. To be available, revenues must be subject to collection within the current period, or after the end of the period, but in time to pay liabilities outstanding at the end of the current period.

Revenues in the proprietary funds are recognized using the accrual basis of accounting, (i.e., in the period in which they are earned). They are classified either as operating or nonoperating revenues. Operating revenues are generated by the primary activity of the fund. Conversely, nonoperating revenues are not generated by the primary activity of the fund, but by other means, such as through grants or interest earnings.

Governmental entities account for a variety of revenues that generally may be presented in the financial statements of governmental funds in three broad categories.

  • Local and intermediate sources are those revenues that are collected from the citizens of the district's service area and governmental and nongovernmental entities both within and outside the school district. Such revenues include property taxes, tuition, and interest income.
  • State revenues are those revenues received from the state, excluding funds passed through the state from the federal government. Such revenues include state grants and state education foundation funding.
  • Federal revenues are those revenues received from the federal government or its agencies either directly or through the state. Such revenues are primarily from federal programs.
Proprietary fund revenues include charges for services, charges to other funds for services rendered, and grant revenues.

Governmentwide Reporting

GASB Statement 34 introduces a number of new reporting concepts for revenues in the governmentwide statements. Essentially, revenues must be classified as either program or general revenues on the Statement of Activities. The following sub-section outlines the basic reporting criteria established for revenues.

Program Revenues

Program revenues are revenues that are directly attributable to a specific functional activity. GAAP requires these revenues to be presented separately in the appropriate functional areas, providing a calculation of net expense for each activity. This net expense often represents the level of support required from the government's own resources. Program revenues include fees collected from those who benefit from the program, grants, and other contributions required by the resource provider to support a specific activity.

Program revenues are reported on the Statement of Activities in the following three categories, if applicable:

  • Charges for services are revenues that arise from charges to customers or applicants who purchase, use, or directly benefit from the goods, services, or privileges provided. Examples are rental fees for school buses or facilities, athletic participant or spectator fees, summer school tuition, or library fines.
  • Program-specific operating grants and contributions are revenues that occur from mandatory and voluntary nonexchange transactions with other governments, organizations, or individuals that are restricted for use in a particular program. An example is a business grant to provide a scholarship for staff training.
  • Program-specific capital grants and contributions are grants and contributions that consist of capital assets or resources that are restricted for capital purposes, such as purchasing, constructing, or renovating capital assets associated with a specific program. These revenues should be reported separately from grants and contributions that may be used either for operating or capital expenses at the judgment of the reporting government. An example is a grant to purchase a school bus.
Program revenues are reported at gross amounts. The Statement of Activities also reports program expenses net of applicable program revenues. GASB Statement 37 clarified that difference captions and additional categories for program revenues may be used.

General Revenues

All revenues are general revenues unless they are required to be reported as program revenues. General revenues are reported in the governmentwide statement of activities after program revenues have been subtracted from functional expenses.

Classification of Revenues

Programs are financed from essentially four sources (see table 4):

  • Type A. Those who purchase, use, or directly benefit from the goods or services of the program
  • Type B. Parties outside the reporting government's citizenry
  • Type C. Taxpayers (regardless of whether they benefit from a particular program)
  • Type D. The governmental institution itself (primarily investment income)
Table 4. Classification of Revenues
Source Type Program Revenue General Revenue
Type A Yes No
Type B Yes, if restricted Yes, if unrestricted
Type C No Yes
Type D No Yes (usually)

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Fund Financial Statements-Reporting of Expenditures/Expenses


GASB Codification Chapter 1600.116 defines expenditures as decreases in net financial resources. In governmental funds, the recognition of expenditures occurs in accordance with the modified accrual basis of accounting. Expenses incurred in proprietary funds are recognized using the accrual basis of accounting. Therefore, significant differences exist between the recognition of expenditures in governmental funds and the recognition of expenses by proprietary funds.

In governmental funds, expenditures are usually recognized in the accounting period in which the goods or services are received and the liability for payment is incurred. However, in instances when current financial resources are not reduced as a result of the incurrence of a liability, an expenditure is not recorded. A common example is the liability for compensated absences (e.g., employee sick and vacation pay). Such liabilities result from current services received from employees; however, the payment of the liabilities usually does not occur until a future date. As a result, compensated absences relating to employees whose salaries are accounted for in governmental funds are not recorded as expenditures and liabilities of the fund until the due date for payment of the compensated absences. GASB Interpretation No. 6 clarifies the guidance for recognizing certain liabilities and expenditures in governmental funds, including general long-term indebtedness such as compensated absences. The matured portion of long-term indebtedness, to the extent it is expected to be liquidated with expendable available financial resources, should be recorded as a fund liability and expenditure. The unmatured portion of the long-term indebtedness represents a general long-term liability to be presented in the governmentwide financial statements.

Types of Expenditures and Accounting Treatments

The major types of expenditures are operating, capital, debt service, and intergovernmental charges. Operating expenditures for governmental agencies include a wide range of expenditures. Often the largest portion relates to payroll and related employee benefits. The modified accrual basis of accounting requires that proper accruals are made for the amount of unpaid salaries and related benefits earned by employees at year-end because these liabilities will be paid early in the next reporting period.

The other types of operating expenditures should be accounted for in the same manner, with the recording of a liability when the goods or services are received and necessary accruals made at year-end.

  • Capital expenditures relate to the acquisition of capital assets. Such expenditures may be recorded in the General Fund, Special Revenue Funds, or Capital Projects Funds, depending on the source of funding. Purchases of personal property, such as furniture and equipment, are usually recorded as expenditures in the General Fund if they are financed from operating budgets or in special revenue funds if they are financed from grants. Major projects, such as the construction of a school building financed by the proceeds of debt, should be accounted for in a Capital Projects Fund. Costs associated with acquiring capital assets in governmental funds are recorded as capital outlay expenditures when the liability is incurred, usually on receipt of the related asset.
  • Debt service expenditures represent the payment of principal and interest needed to service debt. Such payments are usually recorded as expenditures in the Debt Service Fund on the due date. The General Fund may also be used if a Debt Service Fund is not required. The modified accrual basis of accounting provides that accruals for interest are not usually allowed. When funds have been transferred to the Debt Service Fund in anticipation of making debt service payments shortly after the end of the period (no more than 30 days), it is acceptable to accrue interest and maturing debt in the Debt Service Fund in the year the transfer is made. This option is available only if monies are legally required to be set aside in a Debt Service Fund and if used on a consistent basis.
  • Intergovernmental charges relate to the transfer of resources from one school district to another, to or from other local governments, or to or from the state. Examples of such charges include contracted instructional services between public schools, other local governments, or state-operated schools and certain transfers of resources associated with state and local funding (e.g., incremental costs associated with wealth redistribution). Such expenditures are accounted for in the General Fund using the modified accrual basis of accounting. In addition, payments between school districts and fiscal agents of cooperative services arrangements (e.g., joint instructional or servicing agreements) are also considered intergovernmental charges.
In addition, transfers result in the reduction of a fund's expendable resources, but they are not classified as expenditures. A transfer is a legally authorized movement of monies between funds in which one fund is responsible for the receipt of funds and another fund is responsible for the actual disbursement. In a transfer, the disbursing fund records the transaction as "Other Financing Uses" of resources and not as an operating expenditure, whereas the fund receiving the transfer does not record the receipts as revenue but rather as "Other Financing Sources" of funds.


Expenses are defined as the outflows or expiration of assets or the incurrence of liabilities during a period from providing or producing goods, rendering services, or carrying out other activities that constitute the entity's primary operations.

Proprietary funds recognize expenses using the accrual basis of accounting (i.e., when the related liability is incurred) without regard for the timing of the payment. This recognition criterion is consistent with the following guidelines discussed in Financial Accounting Standards Board (FASB) Concepts Statement No. 5. Although FASB Concepts Statements do not represent authoritative guidance for governments, the discussion is useful in classifying expense transactions within proprietary funds.

  • Associating cause and effect. Some expenses (such as the cost of goods sold) are recognized on recognition of revenues that result directly and jointly from the same transactions or other events as the expenses.
  • Systematic and rational allocation. Some expenses (such as depreciation and insurance) are allocated by systematic and rational procedures to the periods during which the related assets are expected to provide benefits.
  • Immediate recognition. Many expenses (such as selling and administrative salaries) are recognized during the period in which cash is spent or liabilities are incurred for goods or services that are used up either simultaneously with acquisition or soon after.
As examples, the major types of governmental expenditures are accounted for differently in proprietary fund expenses as follows:
  • Capital. Capital asset acquisition in proprietary funds is accounted for using the flow of economic resources method. Amounts disbursed for the acquisition of capital assets are not recorded as an expense. Instead, the appropriate property, plant, or equipment asset account is debited on the purchase. Depreciation expense is recorded to reflect the allocation of the cost of the assets to operations over the service life of the asset.
  • Debt service. Principal payments on debt do not represent expenses for proprietary funds, but rather are recorded as a reduction of the obligation. Payments of interest represent expenses to be accounted for on the accrual basis of accounting. Accrual of interest at year-end is usually necessary to reflect the proper amount of expense for the period.

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Governmentwide Statements-Reporting of Expenses

Governmental entities are required to present the governmentwide financial statements on the accrual basis of accounting. Thus, the Statement of Activities reflects the expenses of the entity for the reporting period. Entities are required to report all expenses by activities and programs (by function), except certain indirect expenses, as explained below. GASB has defined direct expenses as those that are specifically associated with a service, program or department and thus are clearly identifiable to a particular function. Direct expenses include both operating and nonoperating expenses, including depreciation and amortization of assets.

Functions, such as general administration or data processing services, may include indirect expenses of other functions. Governmental entities are not required to allocate indirect expenses to other functions, but may choose to do so. If indirect expenses are allocated, direct and indirect expenses should be presented in separate columns. A column totaling direct and indirect expenses may be presented, but is not required. Indirect expenses may be allocated to any of the primary government's functions. Although there are no standards for determining an allocation methodology, there should be a reasonable basis for expense allocations.

Depreciation expense should be included in the statement of activities as follows:

  • Capital assets that can specifically be identified with a function. Depreciation should be included in the direct expenses of that function.
  • "Shared" capital assets. Depreciation should be prorated as direct expenses of the appropriate functions on some reasonable allocation basis.
  • Capital assets that essentially serve all functions. Depreciation is not required to be included in the direct expenses of the various functions but may be reflected as a separate line captioned "unallocated depreciation" in the Statement of Activities or as part of the general government function. If an entity chooses to use a separate line in the Statement of Activities to report unallocated depreciation expense, it should clearly indicate in the footnotes to the financial statements that this line item does not include direct depreciation expenses of the other functions. Because school buildings often serve multiple functions, many school districts are reporting the depreciation as "unallocated depreciation" for these assets.
  • General infrastructure assets. Depreciation should not be allocated to the various functions, but should be reported as a direct expense of the function that the reporting government normally associates with capital outlays or as a separate line in the Statement of Activities.
  • Interest expense. Interest on general long-term liabilities, including interest on capital leases or other vendor financing arrangements, should be considered an indirect expense. Interest on long-term debt should be included in direct expenses only when borrowing is essential to the creation or continuing existence of a program.
The difference between a "shared" capital asset and one that "essentially serves all functions" is the number of functions involved. As the number of functions increases, the ease, practicality, and usefulness of assigning depreciation to those functions decreases. Therefore, the depreciation of assets that serve many, or essentially all, functions is not required to be included in the direct expenses of those functions. A shared capital asset is generally used by only a few functions, and its use can be specifically identified to those functions.

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