Governmental funds

What Are Governmental Funds?

Governmental funds are a major category of accounting funds used by state and local governments in the United States to account for and report on resources that are restricted or committed for specific purposes, rather than for general operations. This approach falls under the broader field of governmental accounting, a specialized area within public finance. These funds are primarily used to account for general government activities and typically employ the modified accrual basis of accounting. Governmental funds exist to demonstrate legal compliance with appropriations and to provide a measure of fiscal accountability for how public resources are used.

History and Origin

The framework for governmental funds and the broader field of governmental accounting in the United States has evolved significantly over the past century. Early efforts to standardize governmental financial reporting began with organizations like the National Committee on Municipal Accounting (NCMA), established in 1934 by the Governmental Finance Officers Association (GFOA). These bodies developed foundational principles for municipal accounting. However, a more formal and authoritative standard-setting process for state and local governments began with the establishment of the Governmental Accounting Standards Board (GASB). The Governmental Accounting Standards Board (GASB) was officially established in June 1984 as an independent, private-sector organization dedicated to setting accounting and financial reporting standards for U.S. state and local governments.⁹,⁸ Its creation aimed to bring consistency and comparability to governmental financial statements, which historically varied widely.⁷ The GASB continues to issue Statements, Interpretations, and other guidance that define generally accepted accounting principles (GAAP) for governmental entities.

Key Takeaways

• Governmental funds account for resources used for general government activities, such as public safety, education, and infrastructure.
• They primarily use the modified accrual basis of accounting, focusing on current financial resources and expendable assets.
• The primary objective of governmental funds is to demonstrate legal compliance and budgetary control.
• Examples include the general fund, special revenue funds, and capital projects funds.
• These funds are distinct from proprietary and fiduciary funds, which have different measurement focuses and accounting bases.

Interpreting Governmental Funds

Understanding governmental funds requires recognizing their distinct measurement focus and basis of accounting. Unlike for-profit entities, which prioritize measuring net income and financial position, governmental funds focus on the flow of current financial resources. This means they are concerned with the inflow and outflow of expendable resources available for spending in the current period or soon thereafter. The adoption of the modified accrual basis means revenues are recognized when they become measurable and "available" (meaning collectible within the current period or soon enough thereafter to pay liabilities of the current period). Expenditures are generally recognized when the liability is incurred, typically when goods or services are received. This approach helps users assess a government's ability to meet its current obligations and provides information critical for budgetary control and demonstrating compliance with spending limits.

Hypothetical Example

Consider a hypothetical city government preparing its financial statements for the fiscal year ending June 30. One of its governmental funds is the Parks and Recreation Special Revenue Fund, established to account for grants and user fees specifically designated for park maintenance and recreational programs.

Here's how some transactions might be recorded within this governmental fund:

1. Grant Revenue: On May 15, the city receives official notification of a $100,000 state grant for park improvements, with the cash expected to be received by July 15. Since the grant is measurable and available within 60 days of year-end, the $100,000 is recognized as revenue in the Parks and Recreation Special Revenue Fund in the current fiscal year, even though cash hasn't been received.
2. Equipment Purchase: On June 10, the Parks and Recreation department orders new playground equipment costing $25,000. The equipment is delivered on June 25, and the invoice is received. The $25,000 is recorded as an expenditure in the current fiscal year, as the liability has been incurred, regardless of when the payment is made.
3. Salaries Paid: On June 30, the city pays $15,000 in salaries to park staff for the last two weeks of June. This cash outflow is recorded as an expenditure.

These transactions directly impact the fund balance, reflecting the flow of current financial resources available for park and recreation activities, aligning with the objectives of fund accounting.

Practical Applications

Governmental funds are foundational to the financial reporting of state and local governments across the United States. They are utilized for core government services that do not operate on a commercial basis. Key types of governmental funds include:

• General Fund: The main operating fund of a government, accounting for all financial resources except those required to be accounted for in another fund.
• Special Revenue Funds: Used to account for the proceeds of specific revenue sources that are restricted or committed to expenditure for specified purposes (e.g., gasoline taxes for road maintenance).
• Capital Projects Funds: Used to account for financial resources to be used for the acquisition or construction of major capital facilities (e.g., new municipal buildings, roads).
• Debt Service Funds: Used to account for the accumulation of resources for, and the payment of, general long-term debt principal and interest.
• Permanent Funds: Used to account for resources that are legally restricted to the extent that only earnings, and not principal, may be used for purposes that support the government's programs.

These funds are crucial for preparing the comprehensive annual financial report (CAFR) of a government, providing detailed information to citizens, bondholders, and oversight bodies. The U.S. Government Accountability Office (GAO) issues guidance on federal financial reporting, and the annual Financial Report of the U.S. Government, prepared by the Department of the Treasury, showcases aggregated governmental financial data.⁶,⁵, [fiscal.treasury.gov/fsreports/fr/fr_final.htm] This financial information underpins public policy decisions, budget allocations, and assessments of a government's financial health and accountability.

Limitations and Criticisms

While essential for government financial reporting, governmental funds and the modified accrual basis of accounting have inherent limitations and have faced criticisms. One primary critique stems from the focus on current financial resources, which can provide an incomplete picture of a government's overall financial health, particularly concerning long-term assets and liabilities. For instance, capital assets (like buildings and infrastructure) and long-term debt are typically not fully reported within individual governmental funds, but rather at the government-wide level.⁴ This can make it challenging for users of financial statements to fully grasp the long-term costs of services or the total value of assets controlled by the government from the fund financial statements alone.

Furthermore, the "availability" criterion for revenue recognition under modified accrual accounting can differ from the revenue recognition principles used in accrual basis accounting in the private sector.³, This difference can lead to less comparability with private sector financial statements and, in some cases, may not fully capture all economic flows. The National Association of State Auditors, Comptrollers and Treasurers (NASACT) acknowledges the unique nature of governmental accounting but also points to the ongoing need to develop and improve standards to meet evolving user needs and address new types of transactions.²,¹ Critics suggest that while modified accrual effectively demonstrates compliance with annual budgets, it may not adequately present the interperiod equity—whether current period revenues are sufficient to cover current period costs.

Governmental Funds vs. Proprietary Funds

Governmental funds and proprietary funds are two distinct categories of funds used in governmental accounting, each serving a different purpose and employing different accounting methods.

The main point of confusion often arises from the differing accounting bases. Governmental funds' modified accrual approach differs significantly from the full accrual method used by proprietary funds, reflecting their distinct operational objectives and the information needs of their primary users.

FAQs

What is the primary purpose of governmental funds?

The primary purpose of governmental funds is to account for financial resources used in general government activities, ensuring legal compliance with budget appropriations and demonstrating accountability for how public money is spent.

How do governmental funds differ from private sector accounting?

Governmental funds primarily use the modified accrual basis of accounting, which differs from the full accrual basis commonly used by private sector entities. This means governmental funds focus on current financial resources and expendable assets, whereas private sector accounting aims to measure overall economic position and net income.

What are some common types of governmental funds?

Common types include the general fund (for general operations), special revenue funds (for specific revenue sources), capital projects funds (for major construction), and debt service funds (for debt repayment).

Who sets the accounting standards for governmental funds?

The Governmental Accounting Standards Board (GASB) is responsible for establishing generally accepted accounting principles (GAAP) for state and local governmental entities in the United States.