What Is Enterprise Funds?
Enterprise funds are a type of proprietary fund used in government accounting to report the financial activities of government operations that are financed and operated in a manner similar to private business enterprises. These funds typically provide goods or services to the general public on a continuing basis, with the intent that the costs of providing these services—including capital costs like depreciation or debt service—be financed or recovered primarily through user charges. This approach enables a government entity to assess the financial performance and self-sufficiency of specific activities, such as municipal utilities (water, sewer, electric), public transportation systems, and airports. Enterprise funds are distinguished by their focus on the accrual basis of accounting, reflecting an economic resources measurement focus similar to that used by private sector businesses.
History and Origin
The evolution of accounting standards for state and local governments in the United States, including the framework for enterprise funds, has been shaped significantly over time. Early efforts to standardize governmental accounting began with organizations like the Governmental Finance Officers Association (GFOA), which established the National Committee on Municipal Accounting (NCMA) in 1934 to promulgate accounting standards. The most significant development affecting enterprise funds came with the Governmental Accounting Standards Board (GASB) Statement No. 34, "Basic Financial Statements—and Management's Discussion and Analysis—for State and Local Governments," issued in June 1999.,, This 23l22a21ndmark standard redefined the financial reporting model for state and local governments, emphasizing the need for comprehensive financial statements that provide both government-wide and fund-level information. GASB St20atement 34 specifically outlined the criteria under which an activity must be reported as an enterprise fund, requiring their use when debt is backed solely by fees, laws mandate cost recovery through charges, or pricing policies are designed to recover costs. This sh19ift aimed to enhance transparency and accountability by requiring governments to report on their business-type activities in a way that allows for the determination of net income and financial position.,
Ke18y17 Takeaways
- Enterprise funds account for government activities that operate much like private businesses, charging fees for services.
- They aim for self-sufficiency, with user charges covering the costs of goods or services provided.
- Financial statements for enterprise funds are prepared using the accrual basis of accounting, similar to commercial entities.
- Examples include municipal water utilities, airports, and public transit systems.
- The Governmental Accounting Standards Board (GASB) sets the accounting and financial reporting standards for enterprise funds.
Interpreting Enterprise Funds
Interpreting the financial statements of enterprise funds allows stakeholders to assess the efficiency and financial viability of specific government services. Because these funds use the accrual basis of accounting, their income statement reflects revenue earned and expenses incurred, regardless of when cash changes hands. This provides a more complete picture of the fund's profitability and ability to recover its costs through user fees. A positive net position over time can indicate that the enterprise fund is financially sound and able to cover its operating and capital costs without reliance on general tax revenues. Conversely, persistent deficits may suggest that the fees charged are insufficient or that the operation is not as efficient as it could be, potentially requiring subsidies from the government's general fund. Analyzing the statements of cash flow statement also provides insights into how the fund generates and uses cash, distinguishing between operating, financing, and investing activities.
Hypothetical Example
Consider the City of Maplewood's Public Water Utility, which is accounted for as an enterprise fund. For the fiscal year, the utility reports $15,000,000 in revenue from water sales to residents and businesses. Its operating expenses for the year, including salaries, maintenance, and depreciation, total $12,000,000. Additionally, the utility incurred $1,500,000 in interest expenses on bonds issued to finance infrastructure improvements.
The financial performance would be:
Revenue: $15,000,000
Operating Expenses: ($12,000,000)
Interest Expense: ($1,500,000)
Net Income (before non-operating items): $1,500,000
This indicates that the Maplewood Public Water Utility generated $1,500,000 more in revenues than its operating and financing expenses for the year, demonstrating a level of self-sufficiency. This surplus could be reinvested in system upgrades or reserves, rather than requiring general taxpayer support.
Practical Applications
Enterprise funds are broadly applied in government entities that provide services to the public for a fee, mimicking the operational model of a commercial business. These applications primarily arise where there's an expectation or a legal requirement for the service to be self-supporting through user charges. Common examples include municipal water and sewer systems, public transportation authorities, airports, and solid waste collection services.,, For i16n15s14tance, a city's water utility would account for all its revenues from water bills and all its expenses related to water treatment, distribution, and infrastructure maintenance within its water enterprise fund. This allows for clear accountability regarding the cost of providing the service and the extent to which user fees cover those costs. The financial reports of enterprise funds, such as those published by entities like Seattle Public Utilities, provide detailed breakdowns of their financial activities, including balance sheet and cash flow statement information, demonstrating how these operations manage their assets, liabilities, and debt financing. This en13sures transparency and helps decision-makers and the public understand the financial health of these essential services.
Limitations and Criticisms
While enterprise funds offer significant benefits in terms of financial transparency and accountability for self-supporting government services, they also have limitations and can face criticism. One primary concern is ensuring that these funds remain truly self-sufficient. If a government-operated enterprise consistently fails to recover its full costs through user charges, it may necessitate subsidies from the general fund, blurring the lines of financial independence and potentially diverting taxpayer money from other essential services. This ca12n lead to questions about whether the activity should continue to be classified as an enterprise fund or if its pricing policies are adequately set to cover all direct and indirect costs, including capital expenditures and debt financing. Additio11nally, critics argue that when governments engage in business-like activities, even through enterprise funds, it can create unfair competition with private enterprises due to inherent governmental advantages, such as tax exemptions or access to lower-cost bonds. Maintai10ning distinct financial reporting for enterprise funds is crucial, as inter-fund transfers that are not properly accounted for could obscure the true financial picture of both the enterprise activity and the general government.
Ent9erprise Funds vs. Special Revenue Funds
Enterprise funds and special revenue funds are both used in fund accounting within government entities, but they serve different purposes and operate under distinct accounting principles. The primary difference lies in their operational nature and the source of their financial support.
- Enterprise Funds: These funds account for government activities that operate like commercial businesses, where services are provided to the public for a fee, and the intent is to recover the costs, including depreciation and capital costs, primarily through those charges. They use the accrual basis of accounting, focusing on net income determination, similar to private sector companies. Examples include water utilities, airports, and public transit.
- Special Revenue Funds: In contrast, special revenue funds are governmental funds used to account for the proceeds of specific revenue sources (other than expendable trusts or for major capital projects) that are legally restricted or committed to finance particular functions or activities. These funds typically use the modified accrual basis of accounting, focusing on the flow of current financial resources. Examples include funds for specific road maintenance funded by a dedicated gas tax, or library funds supported by a special levy. While both restrict the use of funds, enterprise funds do so based on the "business-like" nature and self-sufficiency goal, whereas special revenue funds do so based on the legal restrictions of the revenue source for specific governmental functions.
FAQs
What types of services are typically accounted for in enterprise funds?
Services typically accounted for in enterprise funds are those that charge fees to external users, such as municipal water and sewer utilities, public electric companies, airports, public transportation systems, and often solid waste management.,
H8o7w do enterprise funds differ from other types of government funds?
Enterprise funds differ from other government funds, especially governmental funds, by operating on an accrual basis of accounting, similar to private businesses. They focus on the full cost of providing a service, including depreciation, and aim for self-sufficiency through user charges. Other governmental funds often use a modified accrual basis and focus on current financial resources.,
W6h5y is it important for enterprise funds to be self-sufficient?
Self-sufficiency in enterprise funds is important for several reasons: it ensures that users of a specific service bear its costs, promoting equity; it reduces the need for general tax revenues to subsidize the service; and it provides clear financial accountability for the operation., This a4l3lows for better management decisions regarding pricing and operational efficiency.
Do enterprise funds prepare their own financial statements?
Yes, enterprise funds prepare their own comprehensive financial statements, including a statement of net position (similar to a balance sheet), a statement of revenue, expenses, and changes in net position (similar to an income statement), and a cash flow statement. These statements are then typically included as part of the overall government's annual financial report.,1