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Essentials of Accounting for Governmental and Not-for-Profit Organizations

Chapter 3 Modified Accrual Accounting:


Including the Role of Fund Balances and Budgetary Authority

McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights res

Overview of Chapter 3

The basic accounts used by governmental funds. Recognition criteria for revenues and expenditures under the modified accrual basis. Fund balance classifications for governmental funds.

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Modified Accrual Accounting

The modified accrual basis is a distinct system of accounting that contains financial statement elements that appear nowhere else. Among these are expenditures and fund balances.

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Modified Accrual Accounting

Although, revenues appear in the financial statements of accrual and modified accrual funds, revenues follow different recognition criteria between the two bases. Finally, there are no expenses in modified accrual funds

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Account Structure Permanent Accounts


Accounts that are not closed at year end (Balance Sheet) Assets: Cash and Cash Equivalents Investments Receivables: Taxes Receivable Accounts Receivable Due from Other Governments Supplies Inventories Restricted Assets (typically cash) Liabilities: Accounts Payable Accrued Liabilities Deferred Revenues Fund Balances: Nonspendable Restricted Committed Assigned Unassigned

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Account Structure - Nominal Accounts


Accounts that are closed at year end Budgetary Accounts Estimated Revenues Appropriations Estimated Other Financing Sources Estimated Other Financing Uses Encumbrances Financial Statement Activity Accounts Revenues Tax Revenues Charges for Services Expenditures Current Capital Outlay Debt Service Other Financing Sources Transfers In Debt Proceeds Other Financing Uses Transfers Out

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Assets and Liabilities

Modified Accrual Funds use the Current Financial Resources Measurement Focus

Generally speaking, the assets represent cash and assets that may be expected to be converted into cash in the normal course of operations. (no long-term assets) Similarly, these funds report only those liabilities which will be settled with current financial resources. (no long-term liabilities)
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Fund Balance

The account category, Fund Balance, is unique to governmental funds.

Fund Balance serves a purpose similar to retained earnings, in that activity accounts are closed to this account at the end of each accounting period.

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Fund Balance - interpretation

Since only current financial resources and claims against those resources are recognized in these funds, the difference between assets and liabilities (fund balance) represents the net resources of the fund that are currently available for future spending. However, even current financial resources vary in the extent to which government managers have discretion over their future use and this is reflected by assigning fund balance to five categories (nonspendable, restricted, committed, assigned and unassigned).

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GASB 54 Establishes the Reporting of Fund Balances

The objective of Statement No. 54 is to provide clearer fund balance classifications.

Users want to know whether the use of amounts reported in governmental funds is constrained and how binding those constraints are.

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GASB 54 Fund Balances Financial Statements

Statement No. 54 affects only fund-basis statements of the Governmental Type funds

Does not affect reporting of Net Assets by Proprietary or Fiduciary Funds Does not affect reporting of Net Assets of Governmental Activities in the government-wide statements.

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GASB 54 Fund Balances Summary

Fund balances of governmental type funds are reported within 5 categories


Nonspendable Restricted Committed Assigned Unassigned


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Two Step Process Step 1: Nonspendable resources

Two Step Process Step 1:

Identify those fund resources that are Nonspendable Nonspendable resources include:

Inventories and prepaids (also incudes assets held for sale and
long-term receivables)

The principal (corpus) of a Permanent Fund

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Two Step Process Step 2: Spendable resources

Step 2: Spendable Resources

All remaining net resources of a fund after removing those determined to be Nonspendable
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Spendable resources are further classified according to the nature of any constraints imposed on their use, using a hierarchy of constraints
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GASB 54 Fund Balances Constraint Heirarchy


Restricted Funds Committed Funds Assigned Funds Unassigned Funds
(General Fund) No Constraint Most constrained

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Constraint Hierarchy:
Restricted Funds

Restricted : Constraints placed on the use of resources are:

Externally Imposed (debt covenant, grantor, contributors, or other governments) Imposed by law (constitutionally or enabling legislation)
i.e. enforceable requirement that resources be used only for specified purposes
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Constraint Hierarchy: Restricted Funds

In general, the definition of restricted fund balance is nearly identical to that of restricted net assets in the Government-wide Statements

Exception is Permanent Fund Principle which is classified as Nonspendable in the governmental funds
Fund-Basis Governmental Funds Balance Sheet
Restricted fund balance $ xxx

Government -Wide Statement of Net Assets

Net assets restricted

$ xxx

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Constraint Hierarchy: Committed Funds


Committed:

Constraints placed on the use of resources by:

The formal action of the governments highest level of decision making authority.

GASB 54 specifically identifies Contractual Obligations as one form of committed resources


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Constraint Hierarchy:
Rainy Day Funds

Statement 54 also provides guidance on the classification of budget stabilization or rainy day funds Such stabilization amounts that meet certain criteria are classified as committed or (less commonly) restricted, if imposed externally or by law. Rainy day funds are classified as committed only if they are created by a resolution or ordinance that identifies the specific circumstances under which the resources may be expended.

Rainy day amounts that are available in emergencies or in periods of revenue shortfalls would not be classified as committed unless the emergency or shortfall condition is specified and of a magnitude to distinguish it from events that occur routinely. Rainy day funds not meeting these conditions are reported as unassigned fund balance in the General Fund.

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Constraint Hierarchy:

Assigned Funds

Assigned: The government has an Assigned expressed intent to use resources for specific purpose:

For governmental funds other than the General Fund, this is the category for all remaining (positive) amounts. For the General Fund, assignment conveys a narrower intended use than the general purposes of the government 3-20

Constraint Hierarchy: Unassigned Funds


Unassigned:

Residual classification of the General Fund


Only the General Fund can report a positive unassigned fund balance For other governmental funds this is used only for a negative fund balance (in any of the previous 3 constraint
categories)

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Classification: Step 1
Are there assets not in spendable form? e.g. Inventory & prepaids Required to maintain permanent fund corpus?
ASSETS Cash and cash equivalents Investments

CITY

Balance Sheet

Governmental Funds

As of December 31, 2009

General

Special Revenue Fund 627,837

Capital Projects Debt Service

Permanent

Fund 6,408,214 3,312,992

Fund 895,300

Fund 230,000

Fund 25,366

Receivables (net)

No
Proceed to spendable categories

Taxes receivable

2,872,611

Accounts Receivable

679,215

14,177

Due from Other Governments

1,085,184

243,264

Supplies Inventory

23,747

Restricted Assets

3,933,126

TOTAL ASSETS

18,315,089

642,014

1,138,564

230,000

25,366

CITY

Classification: Step 1
Assets not in spendable form? Inventory & prepaids Required to maintain permanent fund corpus?
General Special Revenue Fund 627,837

Balance Sheet

Governmental Funds

As of December 31, 2009

Capital Projects Debt Service

Permanent

ASSETS Cash and cash equivalents Investments

Fund 6,408,214 3,312,992

Fund 895,300

Fund 230,000

Fund 25,366

yes

Receivables (net)

Taxes receivable

2,872,611

Accounts Receivable

679,215

14,177

Due from Other Governments

1,085,184

243,264

Supplies Inventory
Restricted Assets

23,747
3,933,126

Assume the permanent fund corpus is $ 25,000.

TOTAL ASSETS

18,315,089

642,014

1,138,564

230,000

25,366

LIABILITIES

Classification: Step 2a (Restricted Funds)


Are restrictions imposed by outside creditors, grants, or imposed by law?

CITY

Balance Sheet

Governmental Funds

As of December 31, 2009

yes
ASSETS Cash and cash equivalents Investments

General

Special Revenue Capital Projects

Debt Service

Permanent

Fund 6,408,214 3,312,992

Fund 627,837

Fund 895,300

Fund 230,000

Fund 25,366

Assume the following: Bond sinking fund Federal school lunch grant State highway grant

Receivables (net)

Taxes receivable

2,872,611

Accounts Receivable

679,215

14,177

Due from Other Governments

1,085,184

243,264

Supplies Inventory

23,747

Restricted Assets

3,933,126

TOTAL ASSETS

18,315,089

642,014

1,138,564

230,000

25,366

LIABILITIES

Classification: Step 2b (Committed Funds)


Has city council formally committed funds to specific activities?

CITY

Balance Sheet

Governmental Funds

As of December 31, 2009

yes
General Special Revenue Capital Projects Debt Service Permanent

Assume the following: Construction contracts School construction funds Rainy day reserve

ASSETS Cash and cash equivalents Investments

Fund 6,408,214 3,312,992

Fund 627,837

Fund 895,300

Fund 230,000

Fund 25,366

Receivables (net)

Taxes receivable

2,872,611

Accounts Receivable

679,215

14,177

Due from Other Governments

1,085,184

243,264

Supplies Inventory

23,747

Restricted Assets

3,933,126

TOTAL ASSETS

18,315,089

642,014

1,138,564

230,000

25,366

Classification: Step 2c (Assigned Funds)


Are there positive residual balances in non-General Fund Governmental funds?

CITY

Balance Sheet

Governmental Funds

As of December 31, 2009

yes
General Special Revenue Capital Projects Debt Service Permanent ASSETS Cash and cash equivalents Investments Fund 6,408,214 3,312,992 Fund 627,837 Fund 895,300 Fund 230,000 Fund 25,366

Receivables (net)

Taxes receivable

2,872,611

Accounts Receivable

679,215

14,177

Due from Other Governments

1,085,184

243,264

Supplies Inventory

23,747

Restricted Assets

3,933,126

TOTAL ASSETS

18,315,089

642,014

1,138,564

230,000

25,366

LIABILITIES

Classification: Step 2c (Assigned Funds)


Are there specific resources in the General Fund that are intended for identified purposes?

CITY

Balance Sheet

Governmental Funds

As of December 31, 2009

yes
ASSETS Cash and cash equivalents Investments

General

Special Revenue

Capital Projects

Debt Service

Permanent

Fund 6,408,214 3,312,992

Fund 627,837

Fund 895,300

Fund 230,000

Fund 25,366

Assume the government has outstanding encumbrances for the following: Library acquisitions Other capital projects

Receivables (net)

Taxes receivable

2,872,611

Accounts Receivable

679,215

14,177

Due from Other Governments

1,085,184

243,264

Supplies Inventory

23,747

Restricted Assets

3,933,126

TOTAL ASSETS

18,315,089

642,014

1,138,564

230,000

25,366

LIABILITIES

Classification: Step 2d (Unassigned Funds)


All negative restricted, committed, or assigned net resources are classified as Unassigned.
General Special Revenue Capital Projects

CITY

Balance Sheet

Governmental Funds

As of December 31, 2009

Debt Service

Permanent

The remaining net resources of the General Fund are classified as Unassigned

ASSETS Cash and cash equivalents Investments

Fund 6,408,214 3,312,992

Fund 627,837

Fund 895,300

Fund 230,000

Fund 25,366

Receivables (net)

Taxes receivable

2,872,611

Accounts Receivable

679,215

14,177

Due from Other Governments

1,085,184

243,264

Supplies Inventory

23,747

Restricted Assets

3,933,126

TOTAL ASSETS

18,315,089

642,014

1,138,564

230,000

25,366

LIABILITIES

Accounts payable

2,085,358

70,000

207,134

Classification Completed
General Fund FUND BALANCES Special Revenue Fund Capital Projects Fund Nonspendable Supplies Inventory Permanent fund principal Restricted Bond Sinking Fund School lunch grant Highway grant Committed Construction Contracts School construction Rainy Day Funds Assigned School lunch program Capital projects 95,000 202,014 40,032 3,500,000 120,000 450,000 370,000 302,000 23,747

Debt Service Permanent Fund Fund

25,000

200,000

GASB 54 Fund Balances Encumbrances


Encumbrances Under past reporting practices, outstanding encumbrances at year end were reported in the governmental funds as fund balance: reserve for encumbrances.

Statement 54 requires that significant encumbrances be disclosed in the notes along with required disclosures about other commitments.

However, there is no separate reporting of encumbrances within the fund balance section of the governmental funds balance sheet.

Rather, encumbered resources should be reported within the restricted, committed or assigned categories in a manner consistent with the criteria for those classifications.

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GASB 54 Fund Balances Encumbrances

Encumbrances Interpretation

At the very least, the existence of an encumbrance suggests that the government has an expressed intent to use resources for a particular purpose and therefore these resources should not be classified as unassigned. Encumbrance accounting may also be used in the case of contractual obligations, such as construction contracts. Statement 54 requires that resources obligated to contractual obligations be classified as committed.

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GASB 54 Fund Balances Negative balances

Negative Balances
Statement 54 does not permit the reporting of negative restricted, committed or assigned fund balances. If this occurs, the government should reduce any assigned fund balances (in that fund) by the amount of the negative balance. The rationale is that if expenditures exceed restricted or committed resources, then funds have in effect been reallocated to the purpose used. If a deficit remains once all assigned fund balances are zero, the remaining negative amount should be reported as unassigned fund balance.

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Activity Accounts Sources of funds

Other Financing Sources include transfers in from other funds and the proceeds of long-term borrowing. Revenues are defined as all other inflows and include taxes, charges for services, and amounts provided by other entities such as the state or federal government.

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Activity Accounts Uses of funds

Expenditures are recognized when a liability is incurred that will be settled with current financial resources in the fund. Expenditures may be for salaries (current), land, buildings or equipment (capital) or for payment of interest and principal on debt (debt service). Transfers out of a fund to other funds are classified as Other Financing Uses.

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Classification of Inflows and Outflows on Budget Schedule

Revenues are classified by source


Where the money came from: taxes, licenses and permits, charges for service, etc May be subdivided further such as by type of tax, sometimes shown in separate schedule

Expenditures and Encumbrances may be classified by

function, program, department, activity, character, or object

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Outflow Classifications

Character groupings are always: CURRENT, CAPITAL OUTLAY, and DEBT SERVICE Current are typically classified by function:
General government, public safety, streets and highways

Public safety could be subdivided by department: Police and fire

Police could be subdivided further by activity: Traffic and drug enforcement


Activities in the traffic area could be divided into objects of expenditure: Policemans salary, gas for automobiles

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Budgetary Accounting

GASB standards require governments to present a comparison of budgeted and actual results for the General Fund and special revenue funds with legally adopted budgets. While GASB standards guide the format of this comparison, the GASB does not prescribe budgetary accounting practices and does not require governments to maintain budgetary accounts.

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Recording Budgets

Although budgetary accounts do not appear in the general purpose financial statements, governments typically record budgets and governmental accounting systems are designed to assure compliance with budgets.

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Budgetary Accounts

Revenues to be raised pursuant to law during a budget period are set forth in an Estimated Revenues budget. An Appropriation, when enacted into law, is the legal authorization for the government to incur liabilities for purposes specified in the appropriations statue or ordinance.

Estimated Other Financing Sources and Estimated Other Financing Uses are budgetary accounts reflecting anticipated inflows and outflows of resources from sources other than revenues and expenditures

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Encumbrances

When a purchase order or contract is issued as authorized by an appropriation, the government recognizes this commitment as an Encumbrance.

An encumbrance is not a liability since the goods or services have merely been ordered, not received.

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Encumbrances

Commitments are reflected in the budgetary accounts through the recording of Encumbrances and the corresponding Budgetary Fund Balance - Reserve for Encumbrances.

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Expenditure Cycle

Encumbrance to Expenditure

Once goods or services are received, the government has a liability. At this point, two journal entries are necessary.

The first reverses the encumbrance at its original amount. Since the government has incurred an actual liability, it is no longer necessary to reflect a commitment for the outstanding purchase orders or contracts. The second entry records the liability (Accounts Payable) and an Expenditure in the amount of the invoice.

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Why Record Encumbrances?

In business accounting, orders are not entered into the general ledger

Governments recognize that an outstanding order will turn into an expenditure and a liability when the goods arrive To prevent over-spending, outstanding orders are entered into the books

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Encumbrance Example

Place an order for $150,000 which consists of three mini-buses costing $50,000 each. Recorded as:
Encumbrances Budgetary Fund Balance Reserve for Encumbrances 150,000 150,000

Assume two of the buses arrive, but with freight, they cost $102,000 instead of $100,000.

First, reverse a part of the encumbrances:


Budgetary Fund Balance Reserve for Encumbrances Encumbrances 100,000 100,000 102,000
102,000

Second, record the actual amount of expenditure:


Capital Expenditure
Accounts Payable

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Accounting for Revenues

Since taxes and many other revenues do not involve exchange transactions, governments cannot determine the point at which these revenues are earned.

Therefore revenue recognition occurs when the resulting resources are deemed to be both measureable and available to finance expenditures of the current period.

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Revenue Recognition

Nonexchange transactions are transactions in which a government receives resources without directly giving equal value in exchange. The most common forms of nonexchange transactions are tax revenues and intergovernmental grants. Before a government may recognize revenue resulting from nonexchange transactions, it must meet a number of eligibility requirements.

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Eligibility Requirements Non-Exchange Revenues


Required Characteristics of Recipients. The recipient must have the characteristics specified by the provider. Time Requirement. If time requirements (for expenditure) are specified by the resource provider or legislation, those time requirements must be met Reimbursement. For those grants and gifts that are payable only upon the incurrence of qualifying outlays, revenues would be recognized only when the expenditures have been incurred. Contingencies. Resources pledged that have a contingency attached are not recognized as revenue until the contingency has been met.

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Types of Nonexchange Transactions


1. 1. 1.

Imposed nonexchange revenues


property tax, special assessments, fines/forfeits

Derived tax revenues


sales, income, motor fuel taxes

Government mandated transactions


federal government requires lower level expenditures

1.

Voluntary nonexchange transactions


grants, donations

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Imposed Nonexchange Revenue

Taxes and other assessments that do not result from an underlying transaction.

Examples include property taxes and special assessments imposed on property owners. Also includes fines and forfeits.

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Imposed Nonexchange Revenue


Modified Accrual Basis Recognition
Record the receivable (and an allowance for uncollectibles) when an enforceable claim exits. Revenues should be recognized in the period for which the taxes are levied (i.e. budgeted), but are also subject to the 60 day rule. Revenues expected to be collected > 60 days after year-end are deferred. 1. Taxes Receivable Dr Estimated Uncollectible Taxes ...Cr Revenues Control .Cr 2. Revenues Control Dr Deferred Revenues Property Taxes Cr

1. Property taxes levied 2. Deferral of portion expected to be collected > 60 days after year end

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Derived Tax Revenues

These are taxes assessed on exchange transactions conducted by businesses or citizens.

Examples include sales, income, and excise taxes.

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Derived Tax Revenue


Revenue Recognition Modified Accrual
Record the receivable when the taxpayers underlying transaction takes place. Revenues should be recognized when available and measurable. Revenues not expected to be collected in time to settle current liabilities are deferred (i.e. available and measurable criteria).

1. Income tax withholdings 1. Cash .Dr Revenues Control Cr are received. 2. Additional income taxes 2. Taxes Receivable .Dr Revenues Control Cr expected to be received after year end. Part of this Deferred Revenues Income Taxes Cr will not be received in time to be avail-able for current liabilities.

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Government Mandated Nonexchange Transactions

These are commonly grants from higher levels of government (federal or state) given to support a program.

Since the program is required, the lower-level government has no choice but to accept.

For example, a state may require schools to mainstream certain students and provide funds to carry out this mandate.

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Voluntary Nonexchange Transactions

These include donations and grants given to support a program.

Since the program is not required, the receiving government voluntarily agrees to participate.

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Government-Mandated and Voluntary Nonexchange Revenues


Revenue Recognition Modified Accrual
Record the receivable and the revenue when all eligibility requirements have been met. Many of these are reimbursement grants. In this case, revenue is recognized only when qualified expenditures have been incurred.

Reimbursement type grants

1. Expenditures Control ..Dr Accounts Payable/Cash ..Cr 2. Due from grantor Dr Revenues Control Cr

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Government-Mandated and Voluntary Nonexchange Revenues


Revenue Recognition Modified Accrual Advance funded grant:
Advance receipts are deferred until expenditures are incurred. Revenue recognition is subject to the available and measurable criteria. 1. Cash Dr Deferred Revenues Grants ..Cr

1. Receipt of advance 2a. Expenditures Control ...Dr funding. Accounts Payable/Cash ..Cr 2. Incur qualified expenditures and recognize 2b. Deferred Revenues revenue. Grants .. Dr Revenues Control Cr

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Recording the budget


Estimated Revenues 12,000,000 Estimated Other Financing Sources 500,000 Appropriations Estimated Other Financing Uses Budgetary Fund Balance 11,700,000 250,000 550,000

In the above entry, Budgetary Fund Balance is the expected change in fund balance assuming actual amounts are exactly as budgeted. It may be either a credit (or less frequently) or debit balance in the entry.

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Budget Revisions

Budget revisions may be necessary during the year due to changes in revenue projections or operating conditions for example, electricity price increases, decrease in sales taxes due to low consumer spending

Budget revisions usually are taken back to the appropriate legislative body for approval, although some jurisdictions may allow some percentage of the budget to be transferred between accounts

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Recording a budget revision


Budgetary Fund Balance Appropriations Estimated Revenues 150,000 70,000 80,000

In the above entry, the budget reflects a decrease in estimated revenues of $ 80,000 and an increase in appropriations of $ 70,000.

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Budgetary Comparison Schedule

Both the original and the final adjusted budget is shown The revised appropriations are compared to the Actual Expenditures for the current period plus Outstanding Encumbrances A variance column is typically shown, but is optional

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Budgetary Comparison Schedule

The actual column should use the basis of accounting assumed in the budget. This may be different than GAAP basis

Another schedule will reconcile the actual figures on the budgetary vs. GAAP basis

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