Fund balance

What Is Fund Balance?

Fund balance represents the cumulative difference between assets and liabilities within a specific governmental fund. It is a key metric in public sector finance and governmental accounting, providing insight into the financial health and flexibility of state and local government entities. Unlike the equity reported by for-profit businesses, fund balance specifically pertains to the financial resources of governmental funds and reflects the net available spendable resources, as well as amounts that are legally or contractually constrained from being spent. The classification of fund balance helps users of financial statements understand how government resources can be used, ranging from amounts that are legally restricted to those that are entirely unassigned.

History and Origin

The concept of fund balance in governmental accounting has evolved significantly over time to enhance transparency and provide clearer financial reporting. Historically, governmental accounting standards were developed by various committees associated with the Government Finance Officers Association (GFOA), such as the National Committee on Municipal Accounting (NCMA) and its successor, the National Council on Governmental Accounting (NCGA).²⁶

A major transformation occurred with the establishment of the Governmental Accounting Standards Board (GASB) in 1984.²⁵ The GASB is an independent, private-sector organization responsible for setting Generally Accepted Accounting Principles (GAAP) for state and local governments in the United States. Its mission is to improve governmental financial reporting.²⁴

A significant milestone was the issuance of GASB Statement No. 34, "Basic Financial Statements—and Management's Discussion and Analysis—for State and Local Governments," in June 1999. Thi²³s standard introduced government-wide financial statements prepared on the full accrual basis of accounting, alongside traditional fund-based statements. Whi²¹, ²²le GASB 34 revolutionized governmental financial reporting by enhancing overall financial transparency, it also led to some inconsistencies and misunderstandings in how fund balances were reported across different government entities.

To²⁰ address these issues and provide greater clarity, the GASB issued Statement No. 54, "Fund Balance Reporting and Governmental Fund Type Definitions," in February 2009. Thi¹⁸, ¹⁹s standard substantially altered the focus and terminology for fund balance reporting, replacing previous classifications like "reserved" and "unreserved" with a more defined hierarchy of five categories: nonspendable, restricted, committed, assigned, and unassigned. The¹⁶, ¹⁷ objective of GASB 54 was to enhance the usefulness of fund balance information by providing classifications that could be applied more consistently, thereby making the nature and extent of constraints on fund balances more transparent to users.

##¹⁵ Key Takeaways

• Fund balance is a crucial component of governmental financial statements, indicating the net financial resources of a specific governmental fund.
• It is classified into five categories—nonspendable, restricted, committed, assigned, and unassigned—based on the level of constraint on how resources can be used.
• The Governmental Accounting Standards Board (GASB) is the authoritative body that sets standards for fund balance reporting for state and local governments.
• Understanding the different classifications of fund balance is essential for assessing a government's financial flexibility and its ability to fund future operations.
• Fund balance differs from net assets, which is the equivalent term used in financial reporting for not-for-profit and proprietary entities.

Formula and Calculation

The fund balance for any governmental fund is calculated by subtracting its total liabilities from its total assets. This formula reflects the net financial resources available within that specific fund.

The basic formula is:

Variables:

• Fund Balance: The remaining financial resources of a governmental fund after liabilities are subtracted from assets.
• Total Assets: All economic resources owned or controlled by the specific governmental fund. This includes cash, receivables, and other current assets.
• Total Liabilities: All financial obligations or debts owed by the specific governmental fund. This includes accounts payable, accrued expenses, and other short-term liabilities.

This calculation is performed for each individual governmental fund reported on the balance sheet, such as the general fund, special revenue funds, capital projects funds, and debt service funds.

Interpreting the Fund Balance

Interpreting fund balance involves understanding the constraints placed on a government's spendable resources. The five classifications introduced by GASB Statement No. 54 provide a hierarchy that indicates the degree to which a government is legally or contractually bound to observe specific uses for its resources:

• Nonspendable Fund Balance: These are amounts that cannot be spent because they are either not in a spendable form (e.g., inventories, prepaid items) or are legally or contractually required to be maintained intact (e.g., the principal of a permanent fund).
• R¹³, ¹⁴estricted Fund Balance: This category represents resources whose use is constrained by external parties, such as creditors (e.g., through debt covenants), grantors, contributors, or by laws or regulations of other governments, or imposed by law through constitutional provisions or enabling legislation. For exa¹¹, ¹²mple, grants received for a specific educational program would be considered restricted fund balance.
• Committed Fund Balance: These are amounts that can only be used for specific purposes determined by a formal action of the government's highest level of decision-making authority (e.g., a city council or county commission). These c¹⁰ommitments remain in place unless removed or changed by the same formal action.
• Assigned Fund Balance: This classification indicates that resources are intended for a specific purpose, but without the formal action required for committed fund balance. The intent can be established by the governing body or an official to whom the authority has been delegated. For ins⁹tance, a finance director might assign funds for a future capital outlay project.
• Unassigned Fund Balance: This is the residual classification for the general fund and represents spendable amounts not contained in the other classifications. It is t⁷, ⁸he most flexible type of fund balance, available for any legal purpose. In other governmental funds, a deficit balance resulting from overspending restricted, committed, or assigned amounts would also be reported as unassigned.

By ana⁶lyzing these classifications, users can discern the financial flexibility of a governmental entity, understanding how much of its fund balance is tied to specific uses versus how much is available for general discretionary spending or unforeseen needs.

Hypothetical Example

Consider the City of Riverbend, a hypothetical local government preparing its annual financial statements. The city maintains several governmental funds to manage its operations. Let's look at the financial position of its General Fund at year-end:

General Fund Assets:

• Cash: $5,000,000
• Accounts Receivable (Taxes): $1,500,000
• Inventory (Supplies): $200,000
• Total Assets: $6,700,000

General Fund Liabilities:

• Accounts Payable: $800,000
• Accrued Salaries: $400,000
• Total Liabilities: $1,200,000

First, we calculate the total fund balance for the General Fund:

Next, the City of Riverbend classifies this $5,500,000 fund balance according to GASB Statement No. 54:

1. Nonspendable: The $200,000 in inventory is not in a spendable form.
2. Restricted: A state grant of $1,000,000 was received specifically for a public safety initiative.
3. Committed: The City Council passed an ordinance committing $700,000 for a future road repair project.
4. Assigned: The Finance Director designated $300,000 for equipment replacement within the General Fund.
5. Unassigned: The remaining amount is unassigned.

Calculation of Unassigned Fund Balance:

• Total Fund Balance: $5,500,000
• Less: Nonspendable: $200,000
• Less: Restricted: $1,000,000
• Less: Committed: $700,000
• Less: Assigned: $300,000
• Unassigned Fund Balance: $5,500,000 - $200,000 - $1,000,000 - $700,000 - $300,000 = $3,300,000

Therefore, the City of Riverbend's General Fund balance would be reported as:

• Nonspendable: $200,000
• Restricted: $1,000,000
• Committed: $700,000
• Assigned: $300,000
• Unassigned: $3,300,000
• Total Fund Balance: $5,500,000

This breakdown clearly shows how the $5.5 million fund balance is constrained, from the nonspendable inventory to the flexible unassigned amount.

Practical Applications

Fund balance plays a critical role in various aspects of public finance and governmental operations. Its classifications provide essential information for budgeting, financial analysis, and demonstrating accountability to stakeholders.

For budgeting, the level of unassigned fund balance indicates the financial flexibility a government has to address unexpected expenditures or to fund new initiatives without raising taxes or debt. Governments often maintain a policy for a minimum level of unassigned fund balance to serve as an emergency reserve or for cash flow management throughout the fiscal year.

In f⁵inancial analysis, analysts and rating agencies review fund balance to assess a government's liquidity and long-term financial stability. A healthy fund balance, particularly in its restricted, committed, and assigned categories, can signal prudent financial management and a clear understanding of financial obligations and plans. For example, the impact of significant accounting standards like GASB Statement No. 34, which required governments to report the value of their capital assets and infrastructure, further highlighted the importance of transparent financial reporting that fund balance classifications support.

Furthe⁴rmore, fund balance is crucial for public accountability. Citizens, taxpayers, and oversight bodies can examine the financial statements to understand how public resources are being used and the extent to which they are constrained for specific purposes. This transparency fostered by clear fund balance reporting helps ensure that public funds are managed responsibly and in accordance with legal and administrative requirements.

Limitations and Criticisms

While the modern classifications of fund balance, particularly those introduced by GASB Statement No. 54, aimed to improve clarity and consistency in governmental financial reporting, some limitations and historical criticisms persist.

One challenge is the inherent complexity of governmental accounting itself, which often involves multiple funds with distinct legal and operational purposes. While GASB 54 provides a clearer framework, the detailed distinctions between restricted fund balance, committed fund balance, and assigned fund balance can still require careful interpretation, especially for non-expert users of financial statements. The previous terminology, such as "reserved" and "unreserved," was frequently misunderstood, which led to the need for the updated standards.

Anothe³r limitation can arise if a government does not maintain adequate levels of unassigned fund balance. An entity with a very high proportion of its fund balance in nonspendable, restricted, or committed categories may appear financially sound on paper but could lack the operational flexibility to respond to unforeseen crises or economic downturns. Conversely, a significantly low or negative unassigned fund balance could indicate a reliance on short-term borrowing or an inability to meet ongoing obligations, potentially signaling financial distress.

Despite the intent of GASB 54 to enhance consistency, the application of "committed" and "assigned" classifications can sometimes involve subjective judgments by government management regarding the intent and formalization of internal constraints. While guidelines exist, variations in practice might still occur, affecting comparability across different governmental entities.

Fund Balance vs. Net Assets

Fund balance and net assets are both measures of an entity's financial position, but they apply to different types of organizations and are governed by distinct accounting standards. The primary confusion arises because they represent the "bottom line" on their respective statements of financial position.

Fund balance is specifically used in governmental funds, which typically follow the modified accrual basis of accounting. It represents the difference between current assets and current liabilities within a particular governmental fund. The classifications of fund balance—nonspendable, restricted, committed, assigned, and unassigned—focus on the spendability and constraints on governmental resources.

In contrast, net assets is the equivalent term for equity in not-for-profit organizations and proprietary funds, which adhere to the full accrual basis of accounting. Under FASB Accounting Standards Codification (ASC) Topic 958, net assets are broadly classified into two categories: "without donor restrictions" and "with donor restrictions." Net assets ¹, ²without donor restrictions include resources that can be used at the discretion of the organization's governing board, while net assets with donor restrictions are subject to donor-imposed stipulations as to purpose or time. This distinction highlights the source of restrictions rather than the government's internal decision-making process.

While both terms reflect the residual value of assets after liabilities, their classification systems and the accounting frameworks they operate within are distinct, reflecting the different financial reporting objectives of governmental and non-governmental entities.

FAQs

What is the primary purpose of fund balance?

The primary purpose of fund balance is to report the financial resources of governmental funds and to demonstrate the extent to which those resources are constrained for specific purposes or are available for general use. It helps users understand a government's financial flexibility.

How many classifications of fund balance are there?

There are five classifications of fund balance: nonspendable, restricted, committed, assigned, and unassigned. These categories help indicate the level of constraint on how governmental resources can be spent.

Who sets the accounting standards for fund balance?

The Governmental Accounting Standards Board (GASB) is responsible for establishing the accounting and financial reporting standards, including those for fund balance, for state and local governments in the United States. These standards are part of Generally Accepted Accounting Principles (GAAP) for governments.

Can a governmental fund have a negative fund balance?

Yes, a governmental fund can have a negative fund balance, which is typically reported as a deficit in the unassigned fund balance category. This indicates that the fund's liabilities exceed its assets, often due to overspending from previously restricted, committed, or assigned amounts.

What is the difference between restricted and committed fund balance?

Restricted fund balance refers to amounts constrained by external parties (like grantors or laws), while committed fund balance refers to amounts limited by a government's own highest level of decision-making authority through a formal action. The key difference lies in the source of the constraint—external for restricted, internal formal action for committed.