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Accounting for Governmental and Nonprofit Entities

Chapter One Introduction to Accounting and Financial Reporting for Governmental and Not-for-Profit Entities Topics to Be Discussed: h h h h h h h h h

Government and Non-Profit Entities Similarities and Differences Between Governmental and Other NFP Entities Criteria for Determining NFP as Governmental Entity Major types of governmental and not-for-profit entities Similarities and Differences G & NFP Entities and Business Entities Objectives of financial reporting for G and NFP Entities Sources of Accounting and Financial Reporting Standards for G & NFP entities Financial Reporting for State and Local Government Comparisons of GASB Standard No. 34 Reporting Model with the Old Reporting Model

Learning Objectives: After studying this chapter, you should be able to: h Identify and explain the characteristics that distinguish governmental and not-for-profit entities from for-profit entities. h Identify the authoritative bodies responsible for setting GAAP and financial reporting standards for all governmental and not-for-profit entities. h Contrast and compare the objectives of financial reporting for SLG, the federal government, and not-for-profit organizations. h Explain how management’s discussion and analysis (MD&A), basic financial statements, and required supplementary information (RSI) of SLG relate to their comprehensive annual financial reports. h Explain the different objectives, measurement focus, and basis of accounting of the governmentwide financial statements and fund financial statements of SLG.

1.1) Government and Non-Profit Entities Entities or organizations that are established with operating purpose other than profit making include: a Governmental Entities (Government) a Nonprofit (NP) Entities

What is a Government? A government is a body that has the power to make and the authority to enforce rules and laws within a civil, corporate, religious, academic, or other organization or group. For the purpose the course Government and NFP Accounting, Government can also be defined as an entity that provides such major services as administrative, social, economic, and others either free from charge or with a “token” charge. A government is an organized entity which, in addition to having governmental character, has sufficient discretion in the management of its own affairs to distinguish it as separate from the administrative structure of any other governmental unit. To be regarded as a government, an entity must possess all three of these critical attributes: existence as an organized entity, governmental character, and substantial autonomy. Each is explained below. 1. Existence as an Organized Entity - Evidence of this attribute is provided by the presence of some form of organization and the possession of some corporate powers, such as perpetual succession, the right to sue and be sued, have a name, make contracts, acquire and dispose of property, and the

Compiled By: The G&NP Accounting Instructors

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Introduction to Accounting and Financial Reporting for SLGs

like. Designation of a class of governments in law as “municipal corporations,” “public corporations,” “bodies corporate and public,” and the like indicates that such units are organized entities. 2. Governmental Character - this characteristic is indicated where officers of the entity are popularly elected or are appointed by public officials. A high degree of responsibility to the public demonstrated by requirements for public reporting or for accessibility of records to public inspection, is also taken as critical evidence of governmental character. Governmental character is attributed to any entities having power to levy property taxes, power to issue debt paying interest exempt from Federal taxation, or responsibility for performing a function commonly regarded as governmental in nature. An entity can also be recognized as having governmental character if it meets the indicated requirements as to officers or public accountability. Thus, some districts or zonal governments with no taxing powers are recognized as local governments because of provisions as to their administration and public accountability. 3. Substantial Autonomy - this requirement is met where, subject to statutory limitations and any supervision of local governments by the state, an entity has considerable fiscal and administrative independence. Fiscal independence generally derives from power of the entity to determine its budget without review and detailed modification by other local officials or governments, to determine taxes to be levied for its support, to fix and collect charges for its services, or to issue debt without review by another local government. Some government agencies having considerable fiscal autonomy are classified as dependent agencies of another government rather than as governments because of one or more of the following characteristics: h Control of the agency by a board composed wholly or mainly of parent government officials. h Control by the agency over facilities that supplement, serve, or take the place of facilities ordinarily provided by the creating government. h Provision that agency properties and responsibilities revert to the creating government after agency debt has been repaid. h Requirements for approval of agency plans by the creating government. h Legislative or executive specification by the parent government as to the location and type of facilities the agency is to construct and maintain. h Dependence of an agency for all or a substantial part of its revenues on appropriations or allocations made at the discretion of another state or local government. h Provision for the review and the detailed modification of agency budgets by another local government.

For Example: National Bank of Ethiopia is not a government Example of Governments in Ethiopia: h h h h h h

Federal government of Ethiopia and its agencies The Nine Regional State Governments and Two Administrative City councils 76 Zonal Level Local Governments 587 District Level Local Governments Municipality and Town Governments Kebele level local governments i.e. Kebele is the lower level government in Ethiopia

Government is classified as Special Purpose Government and General Purpose Governments. The Special Purpose Government is a government that provides a single service or few services to the citizenry. For Example: Transportation authorities can be taken as Special Purpose Government Entity. The General purpose government provides a wide collection of services to the citizenry. Examples: Federal government, state governments, zone government, cities, towns, villages, etc

What is Nonprofit (NP) Entity? Compiled By: The G&NP Accounting Instructors

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Accounting for Governmental and Nonprofit Entities

NP Entities are entities other than the government and that provides community services either free from charge or with a “token” charge. The following are the essentials to classify an entity as a notfor-profit: h Legally separate organizations h Its operating purpose is other than to provide goods or services at a profit. h It may not distribute surpluses h Generating profit is not an objective outlined in its legislation, regulations or constitution h It does not pay income tax or income tax equivalents – usually exempt from federal, state, and local taxation h It is not able to transfer ownership Nonprofit entities are classified into two: governmental and non-governmental Examples: Religious entities, community service providers, private educational and health care entities, museums, and fraternal and social organizations, etc In Ethiopia, there are about 660 Nongovernmental NFP entities registered by Ministry of Justice as 2006. Examples: h Save the Children UK and Canada h Family Guidance Association of Ethiopia h Dawn of Hope Ethiopia h Menschen for Menschen h Rift Valley Children and Women Development Fund h National Museum Major Types of Governmental and Nonprofit Entities h General Government – includes federal, state, county, city, town, village, special districts h Educational – includes kindergartens, primary and secondary schools, vocational & technical schools, colleges, and universities h Health and Welfare – Hospitals, Orphanages, the Red Cross and Red Crescent, etc h Religious – churches, mosques, missions h Charitable – includes many NGOs h Foundations - private organizations that promote research and development for improvement of human life.

1.2) Similarities & Differences: Governmental and NP Entities Similarities h Luck of competitive market place .Governmental and NFP entities operate in an environment

which is difficult to set the quality and quantity of service or product h Use of fund accounting as a control device both classes of organization are organized and

operated on fund basis h Significant investment in non-revenue producing activities

Differences Government differs from NP entities in the following manners: h Public corporations and bodies which are politic h Power ultimately rests in the hands of the people – public officials are accountable to the general public and the legislative, judicial, and executive bodies will have an impact on their operation h People can vote and delegate that power to public officials h Government is created by and accountable to a higher level government h Government has the power to tax citizens for revenue – taxpayers are the providers of resources but the contribution may not be voluntary and the tax payers have little say in deciding how to use the resources. h The budget is an expression of public policy and method of providing control. Compiled By: The G&NP Accounting Instructors

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Introduction to Accounting and Financial Reporting for SLGs h The nature of the political process has a significant influence on their operation h They may have monopoly power on some its services

Criteria for Determining NFP Entity as Government An entity is said to be a government if one of the following conditions are met: h Public corporations and bodies politic h Popular election of officers, or appointment of a controlling majority of the governing body by officials of another government h Potential dissolution by a government with net assets reverting to a government h Power to enact and enforce a tax levy

Other NP Organization differs from government with respect to the following points: h h h h

They are accountable to the resource providers (donors) The budget is an expression of the interest of the benefactors. The nature of the political system may not influence their operation The resource providers are donors, or volunteers and the contribution is mostly voluntary

GASB further distinguishes governmental entities from not-for-profit entities and from NP entity by stressing that governments exist in an environment in which the power ultimately rests in the hands of the people. Voters delegate that power to public officials through the election process; the power is divided among the executive, legislative, and judicial branches of the government so that the actions, financial and otherwise, of governmental executives are constrained by legislative actions; and executive and legislative actions are subject to judicial review. Further constraints are imposed on state and local governments by the existence of the federal system in which higher levels of government encourage or dictate activities of the lower levels and finance the activities.

1.3) Similarities and Differences: Business Entities and G & NP Entities Similarities G and NP Entities to Business Entities h Both are integral part of an economic system h Both acquire resources to provide goods or services h Both use financial management processes h Both need financial information systems h Both undergoes cost analyses, control and evaluation techniques h Both may provide similar services – e.g. transportation systems; sanitation services; utilities, stadiums, arenas, etc

Differences between Businesses and G&NP Entities h Organizational objectives h Operational focus h Sources of Financial Resources h Accounting and Financial Reporting h Evaluation of Performance and Operating Results h Regulation and Control h Other Distinguishing Characteristics

Nature of Differences 1. Organizational Objectives

Business Entities

G & NP Entities

h Want to maximize income h Absence of profit motive; from revenues and other h Most are tax exempt; sources. h Want to maximize community services; h They provide services as resources

permit

2. Operational Focus h They focus on short-term h They focus on short-term, annual and also look to long-term

Compiled By: The G&NP Accounting Instructors

budget, and the current year is of primary importance

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Accounting for Governmental and Nonprofit Entities

3. Sources of Financial Resources

4. Accounting and Financial Reporting 5. Evaluation of Performance & Operating Results

6. Regulation and Control

7. Other Distinguishing Characteristics

h They raise resources from h They raise resources from grants, shared

sales, debt transactions, and revenues, and members’ contribution. capital stock. Taxation is unique source of revenue to h The resources form different government. sources are accounted for h No distinction made in sources of differently. financial resources. Owner investment h Benefits are proportional to and sales are insignificant or nonresources provided existent h Accounting and reporting h Accounting & reporting focus on budgets focuses on net income and appropriations and funds and fund accounting, etc h Dual basis of accounting & reporting h Evaluation

focuses on measurement net income. h Businesses are able to modify or withdraw unprofitable goods and services from market places h They are regulated and controlled by the presence of demand & supply mechanisms and profit devices

h Perfect competition h Open market for goods and

services h All the services are provided

at arm’s length prices h Use of matching concept h Use of going concept h Use of periodicity concept rights are h Ownership

transferrable from one owner to the other setting that h Policy maximizes wealth and profit of the owners.

h Profit not a motive and frequently cannot

be measured h Not able to modify or withdraw some unprofitable goods and services from the marketplace. Services not found elsewhere so there is no competition h They face rules and regulations not found in private sector. Statutory, fund and budgetary controls are used. h Regulated by federal, state, & local laws; grant regulations; judicial decisions; charter, by-laws, & ordinances; contractual obligations; trust / donor agreements; organization structure - elected governance, line of authority; personnel policies and procedures h Monopolistic services h No open market for goods and services h User charges based on cost or without profit h Matching is a concept used only in business-type activities h Going Concern is only for business-type activities h Periodicity refers to flow of annual financial resources h Absence of transferable ownership rights h Consensus policy-setting by elected or appointed oversight body

1.4) Objectives of Financial Reporting for G&NP Entities 1. Objectives of Financial Reporting For State and Local Governments (SLGs) Governmental financial reporting objectives are influenced by the characteristics of the state and local governmental operating environment and by the needs of those who use governmental financial reports. GASB Concept Statement No. 1 set forth the following three financial reporting (FR) objectives: Compiled By: The G&NP Accounting Instructors

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Introduction to Accounting and Financial Reporting for SLGs

A) Financial Reporting should assist users is assessing accountability by: h Providing information to determine whether current-year revenues are sufficient to pay for current-year services ( Interperiod Equity) h Demonstrating whether resources are obtained and used in accordance with the entity's legally adopted budget, and demonstrating compliance with other finance-related legal or contractual requirements h Providing information to assist users in assessing the service efforts, costs, and accomplishments of the governmental entity ACCOUNTABILITY is the cornerstone of all financial reporting in government (GASB Concepts Statement No.1, Par. 56). Accountability arises from the citizens’ “right to know.” It imposes a duty on public officials to be accountable to citizens for raising public monies and how they are spent. Interperiod equity relates to accountability. Government officials are accountable and have an obligation to disclose whether current-year revenues were sufficient to pay for current-year benefits or not. If interperiod equity is not achieved, the current citizens are deferring payments to future taxpayers. B) Financial Reporting should assist users in evaluating the operating results of the governmental entity for the year by: h Providing information about sources and uses of financial resources h Providing information about how it financed its activities and met its cash requirements h Providing information necessary to determine whether its financial position improved or deteriorated as a result of the year's operations C) Financial Reporting should assist users in assessing the level of services that can be provided by the governmental entity and its ability to meet its obligations as they become due by: h Providing information about its financial position and condition h Providing information about its physical and other non-financial resources having useful lives that extend beyond the current year, including information that can be used to assess the service potential of those resources h Disclosing legal or contractual restrictions on resources and the risk of potential loss of resources. In general, financial reports are used in SLGs primarily to: h Compare actual financial results with legally adopted budget h Assess financial condition and results of operations h Assist in determining compliance with finance-related laws, rules, and regulations h Assist in evaluating efficiency and effectiveness

2. Objectives Of Financial Reporting For Federal Government Accountability is also the foundation of Federal Government financial reporting. In addition to accountability, Federal Accounting Standards Advisory Board (FASAB) identifies the following financial reporting objectives for Federal Government and its agencies: h FR should assist users in evaluating budgetary integrity h FR should assist users in evaluating Operating Performance h FR should assist users in evaluating Stewardship h FR should assist users in evaluating adequacy of systems and control The users of financial report include citizenry, legislative and oversight bodies, and investors and creditors

3. Objectives of Financial Reporting for NFP Entities NFP financial reporting should provide information useful in: h Making resource allocation decisions h Assessing services and ability to provide services h Assessing management stewardship and performance h Assessing economic resources, obligations, net resources, and changes in them Compiled By: The G&NP Accounting Instructors

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Accounting for Governmental and Nonprofit Entities

1.5) Sources of Accounting and FR Standards for G & NP Entities Financial Accounting Foundation (FAF)

Financial Accountin g Standards Board (FASB)

Business (ForProfit) Organizations

Non-governmental Not-for-Profit Organizations

Governmental Accounting Standards Board (GASB)

Governmental Not-for-Profit Organizations

Gov...