Governmental Accounting Lecture PDF

Chapter One The Governments Environment Dr. sandy Fadel How to gain a higher GPA: 1. More Honest, More Credit 2. More Study , More Return 3. More Effort, More Gain Chapter Outline Learning Objectives LO1 Differentiate between the governments and businesses....

Chapter One The Governments Environment Dr. sandy Fadel How to gain a higher GPA: 1. More Honest, More Credit 2. More Study , More Return 3. More Effort, More Gain Chapter Outline Learning Objectives LO1 Differentiate between the governments and businesses. LO2 Differentiate between the governments and not- for-profits. LO3 Determine the purposes of financial reporting. LO4 Determine the users and uses of financial reporting in Governments. Introduction  Governments organizations have much in common with businesses.  However, the differences between the two environments are sufficiently cleared that business schools have established a separate course in governmental accounting apart from the usual accounting courses—financial accounting, managerial accounting, auditing, and information systems. The Difference Between Governments and Businesses The Difference Between Governments and Businesses  Governments differ from businesses in ways that have significant implications for financial reporting.  Governments and not-for-profits provide services targeted at groups of constituents (voters) either advocating a political or social cause or carrying out research or other activities for the betterment of society.  The objectives of governments cannot generally be expressed in dollars and cents, and are not easily quantifiable. The Difference Between Governments and Businesses 1- Different Missions  The main objectives of a business are (1) to earn a profit—and (2) to ensure that over the life of the enterprise, its owners get a return greater than the amount invested.  The goal of governments is something other than earning profit.  The financial reports of governments can provide information about an organization’s inflows (revenues) and outflows (expenditures) of cash and other resources The Difference Between Governments and Businesses  As a general rule, an excess of expenditures over revenues, particularly for an extended period of time, signals financial distress or poor managerial performance.  However, an excess of revenues over expenditures is not necessarily commendable. An excess of revenues over expenditures may be achieved, for example, reducing the services provided to constituents, which may be at odds with the entity’s objectives. The Difference Between Governments and Businesses  If the financial statements of a government incorporate only monetary measures, such as dollars and cents, they cannot possibly provide the information necessary to assess the organization’s performance.  For an organization to report properly on its achievements , it must increase its financial statements to include nonfinancial data that relate to its objectives.  A school, for example, might include statistics on student achievement, such as test scores or graduation rates. The Difference Between Governments and Businesses 2- Budgets, Not the Marketable, Govern  Governments are governed mainly by their budgets, not by the marketplace.  N.B: budget- estimation of revenue and expense over a specified future period that is evaluated periodically.  These organizations control or strongly influence both their revenues and expenditures through the budgetary process.  The revenues of a government may be determined by legislative action, and if they are, the government may not be subject to the forces of competition faced by businesses. The Difference Between Governments and Businesses 3- Expenditures May Drive Revenues  Governments establish the level of services that they will provide, calculate their cost, and then set tax rates and other fees to generate the revenues required to pay for them.  Unlike businesses, colleges and universities do not set teaching charges at the highest level that the market will bear. Instead, they calculate operating costs, estimate contributions, endowment revenues, and other sources of funds, and then set teaching charges at the rate necessary to cover the shortfall. The Difference Between Governments and Businesses  Although governments do not participate in competitive markets, they cannot simply raise revenues without regard to their services or increase taxes without limit.  Governments may be constrained by political forces. Universities may have to restrict tuition rates to approximately those of same schools. The more funds they raise, the more they spend. The Difference Between Governments and Businesses 4- The Budget, Not The Annual Report, Is The Most Significant Financial Document  For businesses, the annual report is the most important financial document. A major company’s announcement of annual earnings (the preview of the annual report) makes front-page news.  By contrast, its annual budget is nothing more than an internal document, seldom made available to investors or the general public. The Difference Between Governments and Businesses  For governments, the budget takes center stage, because the budget is the culmination of the political process.  It summarizes almost all the decisions and consequences made by the organization.  It determines which constituents give to the entity, which receives, which activities are supported, and which are assessed. The Difference Between Governments and Businesses  Because it is so important, the budget, unlike the annual report, (1)is a source of concern and disagreement among voters. Government budget hearings often draw standing-room-only crowds to the legislative chambers.  A government’s budget may be supported by the force of law.  State and local government officials are forbidden from spending more than what was budgeted. The Difference Between Governments and Businesses 5- Budgets Drive Accounting And Financial Reporting  Constituents of an organization want information on the extent of adherence to the budget. They want assurance that the organization has not spent more than what was authorized. They want to know whether revenue and expenditure estimates were reliable.  The accounting system and the resultant financial reports must be designed to provide that information. The Difference Between Governments and Businesses  In addition, managers need an accounting system that provides them with ongoing data about whether they are on target to meet budget projections. Even more critically, they need a system that either prevents them from overspending or sets off warning signals when they are about to do so.  The budget is a control device, but it requires the support of a complementary accounting and reporting system. Quick Check 1. In addition, The traditional business model of accounting is inadequate for governments and not-for-profit organizations primarily because businesses differ from governments and not-for- profit organizations in that: A. They have different missions B. They have fewer assets C. Their assets are intangible D. Taxes are a major expenditure of businesses Quick Check 2. If businesses are “governed by the marketplace,” governments are governed by A. Legislative bodies B. Taxes C. Budgets D. State constitutions Quick Check 3. The primary objective of a not-for-profit organization or a government is to A. Maximize revenues B. Minimize expenditures C. Provide services to constituents D. All of the above The Difference Between Governments and Businesses 6- Need To Ensure Interperiod Equity  Most governments are required by law, and most not-for- profits are expected by policy, to balance their operating budgets.  Balanced operating budgets ensure that, in any particular period, revenues cover expenditures and that, as a group, the entity’s constituents pay for what they receive.  If organizations fail to balance their budgets—and borrow to cover operating deficits—then the cost of benefits enjoyed by the citizens of today must be borne by those of tomorrow. The Difference Between Governments and Businesses  The concept that voters pay for the services that they receive and do not shift the burdens to their children has traditionally been labeled as intergenerational equity.  In recent years, to emphasize that entities should not transfer the costs even to future years, to say nothing of future generations, the term interperiod equity has been accepted as more appropriate.  interperiod equity: “Financial reporting should provide information to determine whether current-year revenues were sufficient to pay for current-year services”. The Difference Between Governments and Businesses  The prohibition against debt applies only to operating, not capital, expenditures.  A government constructed highway or university- purchased lab equipment will produce benefits over more than one year. It is only fair, that they be paid for by incorporating debt service costs into the taxes or teaching charges of the citizens or students who will benefit from them. The Difference Between Governments and Businesses Fiscal practices that promote interperiod equity: 1. Issuing 30-year bonds to finance the purchase of a new building that is expected to have a useful life of 30 years, repaying the bonds, along with appropriate amounts of interest over the 30 year period. 2. Paying the current year costs of an administrative staff out of current operating funds. The Difference Between Governments and Businesses Fiscal practices that undermine interperiod equity 1. Financing the purchase of the new building with 30 year zero coupon bonds that permit the entire amount of principle and interest to be paid upon the maturity of the bonds, making no provision to set aside resources for payment of principal and interest on the bonds until the year they mature. 2. Issuing 30 year bonds to finance the current year operating costs of an administrative staff. The Difference Between Governments and Businesses 7- Revenue Not Indicative Of Demand For Goods Or Services  For competitive businesses, revenues signal customer demand for goods and services. Holding prices constant, the greater the revenues, the greater the demand—an indication that the entity is satisfying a societal need. The Difference Between Governments and Businesses  In a government or not-for-profit, revenues may not be linked to constituent demand or satisfaction. An increase in tax revenues, for example, tells nothing about the amount or quality of service provided. Therefore, a conventional statement of revenues and expenditures cannot supply information on demand for services. Supplementary information is required. Quick Check 1- Interperiod equity refers to a condition whereby A. Total tax revenues are approximately the same from year to year B. Taxes are distributed fairly among all taxpayers, regardless of income level C. Current-year revenues are sufficient to pay for current-year services D. Current-year revenues cover both operating and capital expenditures Quick Check 2- Which of the following practices is most likely to undermine interperiod equity? A. Paying for a new school building out of current operating funds B. Paying the administrative staff of a school out of current operating funds C. Issuing 20-year bonds to finance construction of a new highway D. Recognizing gains and losses on marketable securities as prices increase and decrease