Chapter 3 Issues of Budgeting and Control

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Thought to Ponder: Chapter 3

"A budget is more than simply numbers on a page. It is a measure of how well we are living up to our obligations to ourselves and one another." President Barack Obama

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Learning Objectives
 Key Purposes of Budgets  Various ways of classifying expenditures  Key Phases of the Budget cycle  Limitations of Actual-to-budget comparisons  How an encumbrance system prevents overspending  How budgets enhance control
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Budgets
Key Purposes of Budgets
 Planning  Controlling and Administering  Reporting and evaluating

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Budgets in Government are MUCH MORE IMPORTANT than they are in Business


The General Fund and special revenue funds usually require a legally adopted budget before the government can collect revenues from taxes and other sources and incur expenditures. Severe penalties may exist for failure to comply with the budget, so it is imperative that the accounting system facilitate accounting for the budget as well as all other operating transactions.

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Major types of Budgets

 Appropriation Budget
 Monitors current or operating fund (i.e. general fund)  Typically covers one operating cycle

 Capital Budget
 Monitors construction and acquisition of long-lived assets  Typically covers multiple years

 Flexible Budget
 Contains alternative budget estimates based on varying levels of output  Helps distinguish fixed and variable costs  Most useful to business-type activities where level of activity depends on customer demand

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Key Phases of Budget Cycle

 Preparation  Legislative adoption and executive approval  Execution  Reporting and auditing
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Current GASB Model Vs. Old Model

 Old model: governments reported only their amended budget.  Current model: requires the actual results and both the original and final appropriated budgets.  Budgetary compliance can be assured by building safeguards in the accounting systems.  Journals  Ledgers
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CITY OF HOUSTON GENERAL FUND BUDGET FOR FISCAL YEAR 2008 (unaudited) (amounts expressed in thousands)

Total Budgeted Resources Total Budgeted Expenditures Designated "Sign Abatement" Amount Designated "Rainy Day" Amount Budgeted Ending Fund Balance as of June 30, 2008 Total Budgeted Expenditures and Reserves
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$ 1,984,199 1,768,473 2,070 20,000 193,656 $ 1,984,199

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Budgetary Accounts Purpose: Used to record the budgetary inflows and outflows estimated or authorized in the annual budget Accounts:  Estimated Revenues, Estimated Other Financing Sources  Appropriations, Estimated Other Financing Uses  Encumbrances
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Budgetary and Operating Statement Accounts

 Revenues and Other Financing Sources increase fund balance when closed. Both are recognized on the Modified Accrual basis--when measurable and available to pay current period obligations. Expenditures and Other Financing Uses decrease fund balance when closed. Both are recognized on the Modified Accrual basis--when incurred, if expected to be repaid from currently available resources of the fund.

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Budgetary and Operating Statement Accounts (contd)

 An appropriation is a legal authorization granted by the legislative body to incur liabilities for purposes specified in the appropriation act or ordinance.

Lets do a simple example

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Example A
A city government incorporates its budget in its accounting system and encumbers all commitments. Prior to the start of the year, the city council adopted a budget in which city revenues were estimated at $500,000 and expenditures of $450,000 were appropriated. Record the budget using only the control accounts. Estimated revenues Appropriations Fund balance
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$500 $450 50
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Next slide shows what the detail might look like

Examples of Budgetary Journal Entries (A)

Budget Approved on 1-1-2010: Estimated Revenues Appropriations Fund Balance Revenues Ledger: Taxes Licenses and Permits Intergovernmental Revenues Charges for Services Fines and Forfeits Miscellaneous Revenues Appropriations Ledger: General Government Public Safety Public Works Culture and Recreations
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Dr. 500,000

Cr. 450,000 50,000

300,000 50,000 50,000 50,000 25,000 25,000

$500,000

$450,000

120,000 150,000 100,000 80,000

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Budgetary and Operating Statement Accounts (contd)

An encumbrance is an estimated amount recorded for purchase orders, contracts, or other expected expenditures chargeable to an appropriation.

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Encumbrance
 Prevents overspending the budget  Entry to record encumbrance is made when purchase order is issued, a contract is signed, or a commitment is made.  Entry that records encumbrance reduces the budget available for expenditure.  Outstanding encumbrances are reported in the notes to the entitys financial statements No longer on face of balance sheet per GASB 54.
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Impact of GASB 54
Significant encumbrances must be reported in the notes to the financial statements
 A separate display of encumbrances within fund balance categories is not permitted  In the general fund: add encumbrances not related to restricted, committed or assigned purposes to the unassigned fund balance  In special purpose funds: add encumbrances for specific purposes to the appropriate committed or assigned fund balance
 This requirement is necessary because special purpose funds cannot report a positive unassigned fund balance
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Lets do an example with encumbrances

Based on the Example posted on Blackboard

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Budgetary Control Expenditures

 Budgetary control of expenditures is achieved by: ensuring that a valid appropriation exists prior to recording an encumbrance or expenditure, and periodically comparing encumbrances and expenditures to appropriations. Comparison is enhanced by using a common classification scheme for appropriations, encumbrances, and expenditures
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Example B - Budgetary Control

Example: City Clerk's office orders a new multipurpose machine on January 2, 2010 which had a list price in the vendor's catalog of $500. General Fund General Journal: Dr.
Encumbrances--2010 $500 Reserve for Encumb.--2010

Cr.
$500

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Accounting Control over Expenditures

 Appropriations (expenditure budget)  Estimated revenues & other sources of financing (revenue budget)  Encumbrances (unfilled orders) The sum of the detailed Appropriations, Encumbrances, and Expenditure account balances of the subsidiary ledger must equal the general ledger control account balances

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Accounting model for the General Fund

ASSETS = LIABILITIES + FUND BALANCE
Balance Sheet Accounts (permanent) Budgetary/ Operating Statement Accounts (temporary)
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Reserved (Nonspend + Rest., Comm., & Assign) FB

+ Unreserved (Unassig) Fund Balance

Budgetary Accounts

Operating Accounts

Classification of Expenditures
GASB suggestions classifying expenditures by any of the following:
  Fund  Ex. general fund, special revenue fund, etc. Function or Program  Def. Group of activities carried out with the same objective  Ex. general government, public safety, sanitation, etc. Organization Unit  Ex. police department, fire department, etc. Activity  Def. Line of work contributing to a function or program  Ex. highway patrol, burglary investigations, etc. Character  Def. The fiscal period presumed to benefit  Ex. Current, Capital, Debt Service Object  Def. The types of items purchased or services obtained  Ex. Salaries, fringe benefits, travel, etc.
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Most Commonly Used Budget . . .

Object Classification Budget

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Object Classification Budget

 Traditional and most common  Facilitates control

Drawbacks:
 Discourages planning  Promotes bottom-up budgeting than top-down budgeting  Overwhelms top-level decision-makers with details  Limits post-budget evaluation
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Classification of Revenues and Estimated Revenues

GASB Suggestion:
 1st classify by fund  2nd classify by source FUND S O U R C E
Sources include:  Taxes (Ad-valorem and self-assessing)  Special Assessments  Licenses and Permits  Intergovernmental Revenues  Charges for Services  Fines and Forfeits  Miscellaneous Revenues

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On What Basis of Accounting are Budgets Prepared?

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Basis of Accounting
 Neither GASB nor FASB have control over budgeting principles Budgeting principles are set by either the government/organization or the government/organization that supervises them  GASB recommends using modified accrual basis of accounting.  However, most governments use the cash basis for their budgets.
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Cash Basis Budgeting

 Budgeting principles are established by individual governments or organizations and not by GASB nor FASB.  Although GASB recommends the use of modified accrual basis in preparing the annual budgets, many governments adopt cash basis or modified cash basis.

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Cash Basis Budgeting

Governments using cash basis:  Assign revenues and expenditures to the period during which the cash is expected to be received or disbursed.  Treat encumbrances equivalent to actual purchases.  Recognize taxes and other revenues in the year in which they are due and not in the year in which they are expected to be collected.
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Cash Basis
Disadvantages:
 May distort the economic impact of planned fiscal activities.  May be unbalanced as to economic costs and revenues.  It may give an appearance of a budget that has achieved inter-period equity when it really has not.  Makes it easier to transfer resources from a fund that has a budget surplus to one that needs extra resources.  Complicates financial accounting and reporting.
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Legally adopted budgets vs. GAAP-based Financial Statements

Differences arise between the legally adopted budgets and GAAP-based financial statements. They are caused by:  Basis of accounting  Timing  Perspective  Reporting entity
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Performance Budgets
 Supplement to object classification budgets  Focus on measurable units of efforts  Institutionalize effective decision process  The most common type of performance budget is program budget.

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Recording Budgets Example

Additional examples to study (beyond textbook and ones we did in class)

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Recording Budgets
 Estimated revenues (DB) Actual Revenues (CR) = Remaining revenue to be recognized  Appropriations (CR) - Actual expenditures (DR) = Balance available for expenditure  Refer to pgs. 105-108 for budgeting entries.
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Example C
A government health care district incorporates its budget in its accounting system and encumbers all purchase orders and contracts. Prior to the start of the year, the governing board adopted a budget in which agency revenues were estimated at $5,600 and expenditures of $5,550 were appropriated. Record the budget using only the control accounts. JE 1: Estimated revenues Appropriations Fund balance
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$5,600 $5,550 50
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Example - C (contd)
JE 2: During the year, the government health care district collected $5800 in fees, grants, taxes, and other revenues. Prepare journal entries.
Cash Revenues $5,800 5,800

JE 3: It ordered goods and services for $3,000.

Encumbrances $3,000 Reserve for encumbrances
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3,000
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Example C (contd)
JE 4: During the year it received and paid for $2,800 of goods and services that had been previously encumbered. It expects to receive the remaining $200 in the following year. a: Expenditures Cash b: Reserve for encumbrances Encumbrances $2,800 2,800 $2,800 2,800

JE 5: It incurred $2500 in other expenditures for goods and services that had not been encumbered. Expenditures Cash
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$2,500 2,500
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Example C (contd)
Prepare end of year closing entries. JE 6: Revenues
Estimated revenues Fund balance $5,800 5,600 200 $5,550 5,300 200 50

JE 7: Appropriations
Expenditures Encumbrances Fund balance

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Supporting Computations original style

bal fwd 3 4b Reserve for Encumbrances dr cr balance $0 3,000 (3,000) 2,800 Fund balance (unassigned, unreserved) dr cr balance 0 50 (50) 200 (250) 50 (300) (200) (200) bal fwd 3 4b 7

Encumbrances (temporary acct) dr cr balance 0 3,000 3,000 2,800 200 200 0

bal fwd 1 6 7

Total fund balance at year end: Fund balance committed (Reserved for encumbrances ) Fund Balance Unassigned (unreserved) Total This should equal revenues expenditures (since bal fwd in FB was 0)

200 300 500

Revenue Expenditures = 5,800 5,300 = $500

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Example C (alternate style closing)

Fund= General Fund JE 6 Reverse original budgetary entry: Appropriations Fund balance (unassigned) Estimated revenues JE 7 Close revenue, expenditure & encumbrance accounts Revenues Expenditures Encumbrances Fund balance (unassigned)
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Debit $5,550 50

Credit

5,600

$5,800 5,300 200 300

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Supporting Computations alternate style

bal fwd 3 4b Reserve for Encumbrances dr cr balance $0 3,000 (3,000) 2,800 (200) (200) Encumbrances (temporary acct) dr cr balance bal fwd 3 4b 7 0 3,000 200 0

3,000 2,800 200

bal fwd 1 6 7

Fund balance (unassigned, unreserved) dr cr balance Total fund balance at year end: Fund Balance committed 0 50 (50) (Reserved for encumbrances) Fund Balance -Unassigned 50 (unreserved) 300 (300) Total

200 300 500 5,800 5,300 500

This should equal revenues - expenditures since balance fwd was zero TRUE

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City of Houston - Facts

Did you know?
 The final sales tax revenue for FY 2009 was $507 million, 2.4 % more than FY 2008 amount.  Sales taxes comprise 21% of the citys revenue source for governmental activities.  Total unreserved fund balance of the General Fund for FY 2009 was $281 million.

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Summary
 The General Fund and special revenue funds usually require a legally adopted budget before the government can collect revenues from taxes and other sources and incur expenditures. Severe penalties may exist for failure to comply with the budget, so it is imperative that the accounting system facilitate accounting for the budget as well as all other operating transactions. END!
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