Financial Statements in Government: A Compliance and Liquidity Approach

Glossary for chapter III of Financial Reporting in Government
By Dr. John Sacco , George Mason University
Revised Saturday, April 12, 1997

account groups: Because governments make a sharp distinction between current and long term items, governmental financial statements need a place to put long term activities (ie, assets and liabilities). Account groups are used for this purpose. Since account groups are consider memoranda, they do not need to follow strict accounting rules. For example, long debt may be back only by the full faith and credit (ie, the taxing and borrowing power) not any current assets.
accounting rules: The phrase accounting standards is also used. However, the purpose is the same. In order to increase compatibility among governments issuing financial reports, rules or standards are established so that similar transactions and events will be handled similarly. For instance, what is the rule for handling real estate property tax. Is it included at the beginning of the year before the tax is actually collected or only as the tax is collected?
accrual: In developing a conceptual framework for accounting and financial reporting, accrual recognizes transactions and events when the activity occur regardless of when the cash changes hands. As long as something is estimatable and probable it is recognized. Estimating how much pension a person is due from working one year even though the person might not receive the pension for many years is an example of accrual.
annual budget: Annual is a period of one year. In government, much of the accounting and financial reporting is geared to things that will happen and involve cash during the fiscal year. This focus is driven by the approval and execution of the annual budget. The budget covers the governmental decisions on how to raise money and where to spend it. Traditionally, one of the most public decisions in government. A government may have several budgets for the different funds in government. The budget for the general fund is usually the largest. Financial reports, which should assess financial performance, including compliance with budget, are not nearly as widely debated or circulated.
articulation: In understanding financial statements it is important to realize that in business accounting, the financial statements are closely linked to each other. The net profit or loss is carried to the equity section of the balance sheet. The larger the profit and the more years of profit, the more that goes into the equity section of the balance sheet. With a large equity the balance sheet looks healthy and the firm is in a position to distribute this equity to the owners.
balance sheet: The intend of this statement is to show the financial position, conditions, or health in terms of liquidity. That is, can the unit pay its bills with the assets on hand, or can the unit take advantage of emerging opportunities with the assets available. For governmental funds, the balance sheet is restricted to items of short term liquidity, that is, can the government meet liabilities or take opportunities in the next few months.
bonds: Officially called debt securities, bonds provide ways for governments to raise large sums of money by borrowing. Bonds usually have a principle amount and a contract interest rate. The principle can be paid at maturity while the interest is generally paid semi-annually as a percent of the principle. For example, a government could see 10,000,000 in bonds with a 5% interest rate. If the bonds matured in five years, then the 10,000,000 would have to be paid to the bondholder. During that period, 500,000 would have to be paid in interest each year or 250,000 semi-annually. These bonds would be called term bonds since they are due at point in time. Serial bonds come due at different points in time.
capital project: A large effort resulting in a major asset such as construction of a building or purchase of a building is a capital project. The resulting asset will have a life of longer than a year and entail a major expenditure.
cash accounting: In developing a conceptual framework for accounting and financial reporting, a cash basis recognizes transactions and events only when cash changes hands. The cash basis is the opposite of the accrual.
combined: A combined financial statement is the highest level of summarization or aggregation. For example, a government may have two or more capital project funds. In the combined statement, these would presented in one column as capital projects.
combining: A combining financial statement is at a second level of aggregation below the top or combined level. If each fund in a fund type is presented on one page this is a combining level. For example, if special revenue funds have three funds, parks, schools, and libraries, then the combining level would present the three on the same page.
compliance: Compliance assesses whether actual money raising and spending adhere to budget mandates set by the legislative body. All the financial statements can help judge compliance, but one in particular call budget versus actual is used to assess compliance. Historically, annual compliance with the budget has been the main factor shaping governmental financial reports.
components (component units): Because of the complexity of governments and government organizations in a single jurisdiction, financial reporting must be designed to capture this complexity. A component unit is a legally separate or significant unit vis a vis the primary reporting jurisdiction. A water authority may be legally separate from a county but the board of the authority may be appointed by the elected officials of the county. In this case the authority is a component unit and its financial statements must be summarized in the CAFR.
conditions: Financial conditions or position or health go mainly with the balance sheet. The idea behind the financial conditions is an assessment of whether the government has sufficient assets to cover its liabilities. Since governmental balance sheets are mainly for current or annual activities, conditions refer to whether current assets can cover current liabilities. However, long term liabilities can be introduced in a variety of ways to assess conditions. Long term debt can be compared to indicators of tax capacity to determine if a government is putting too much pressure on its capacity. Debt as a ratio of total real estate value is sometimes used to assess long term financial conditions.
consolidation: For sundry reasons including economic, legal or tax factors, activities are operated in separate units but essentially controlled by or accountable to one overarching unit. If all these units are summed or aggregated in the financial report (of course eliminating any double counting) then the report is said to be consolidated. In business, consolidated reports are the practice and there are specific accounting rules for consolidation. Governments, even though one unit may be accountable for many subunits or subentities, do not report on a consolidated basis. Thus, no one set of numbers exits for the entire unit or jurisdiction.
current: Essentially, the same as annual. In government, much of the accounting and financial reporting is geared to things that will happen and involve cash during the fiscal year.
liquid assets: Essentially the same as liquidity. Liquidity refers to how quick an asset can be converted to cash. A three-month treasury note is probably more liquid than a backhoe, but probably less liquid than money in a checking account.
efficiency and effectiveness: Efficiency should be a measure of how much input was required to achieve a certain amount of output. It is a productivity measure. Effectiveness assess how much of a problem or opportunity was handled. It measure amount or degree of accomplishment.
expenditures: Governmental accounting uses the term expenditures to differentiate government rules from business rules. In business, the term expense is the phrase of choice. Expenditures is used in government to show the modified cash or modified accrual basis. When some item is purchased with cash or an account soon to be paid it is an expenditure. In business an item is an asset until it is used to help generate revenue. In other words the matching principle guides recording of expenses. Promises are handled differently too. In government, they are not likely to get recorded as expenditures until the promise demands cash. In business, if a promise is earned in the process of generating revenue it is deemed an expense even though it may not demand cash until well into the future.
fiduciary funds: What cuts across these is that someone is holding money for someone or something else. The government is usually very restricted in what it can do with the money in these funds. Two fiduciary funds are the trust and agency.
financial performance: Performance is used as an all embracing term to include financial success, conditions, and compliance. It is historical in perspective, referring to performance during a period (perhaps a year) just past.
fixed assets: They are also called property, plant and equipment. These are assets used to help run or operate the government. Specifically, they many include vehicles, buildings, and machines. Under ordinary circumstances, they are not expected to be converted to cash to pay bills.
flow of current financial funds: The official phrase used in governmental accounting to characterize the focus of what is to be included in the governmental statements and what is not to be included. Money passing through is to be included regardless of whether its revenue, transfers among funds, or borrowing. Fixed assets or long term obligations that do not require immediate payment are excluded.
flow of economic resources: This is the focus used in business accounting. It includes both short and long term items compared to the flow of current financial funds which includes only short term items such as cash. The flow of current financial funds is presently used in government as the focus of what to include in the governmental funds.
full faith and credit: People who are creditors of government are often protected from loss by the full faith and credit of the government. This means that the government will either use future taxes or borrowing to pay off loans or bills. financial performance: Performance is used as an all embracing term to include financial success, conditions, and compliance. It is historical in perspective, referring to performance during a period (perhaps a year) just past.
funds: One of the fundamental principles of governmental accounting is the fund. Funds are usually established by legislation and provide an accounting mechanism for keeping track of money raised and spent for a specific activity or set of activities. Governments have three broad type of funds and specific funds within those broad type of funds.
fund balance: When liabilities are subtracted from assets, there is a fund balance. A positive fund balance means there are more assets than liabilities; a negative fund balance means just the opposite. Fund balance can be complicated by the fact that part of the fund balance is reserved and part unreserved. The difference between reserved and unreserved is that the unreserved can potentially be authorized for future expenditures while the reserved cannot. Additionally, the fund balance is a residual and not necessarily a cash amount.
GAAP: GAAP means Generally Accepted Accounting Principles. These are the principles that practitioners use to produce financial statements. They can become accepted via due process or via long term practice or both. It is the GAAP that help make financial statements compatible from year to year and jurisdiction to jurisdictions.
GASB: GASB stands for Governmental Accounting Standards Board. It was organized in 1984. Like FASB it falls under the umbrella of the Financial Accounting Foundation. It makes rules for state and local government and nonprofits controlled by government. GASB is recognized by the Securities and Exchange Commission (SEC) as the rule making body for state and local government. It follows due process in that interested parities can comment before rules are accepted. GASB is independent in that its costs are covered by contributions.
governmental funds: These include general, special revenue, capital project, and debt service. They measure how government is doing in the short term and often in comparison to the budget.
income statement: One of the financial statements used in business is the income statement. It is commonly referred to a bottom line type of statement. It shows whether the business earned a profit or incurred a loss for a given period. Some government programs are carried out like business operations and in those cases a statement similar to the income statement is produced.
individual: This is usually the lowest level of presentation of a fund in a financial statement. One single fund would be presented. For instance, if the combining level had parks, schools, and libraries, then the individual level would give a page to each.
interest: Interest is the cost for using money. In the case of bonds sold by government, there will likely be a contract interest rate. For instance, if the contract interest rate is 5% and the amount of bonds sold is 1,000,000 then the annual interest is $50,000.
intergeneration equity: Future generations should not have to pay for benefits received by current generations.
interperiod equity: This goal has been adopted by GABS in its objectives of financial reporting. The idea is that governments should raise enough revenue to cover all services for a given period, generally a year. Services should not be provided that will put a burden on future taxpayers or generations.
level of aggregation within funds: Since a single fund type can have many funds within it, the financial statements aggregate at different levels. The highest is combined and there only the fund type is shown (eg, special revenue or capital projects). The next level is combining. Here each fund within a type is show but they are show in column format. Thus, if the capital projects fund has five separate funds these would be shown in column format as under the title, combining. If each fund were shown separately for each statement, the title would be individual.
liquidity: Liquidity refers to how quick an asset can be converted to cash. A three-month treasury note is probably more liquid than a backhoe, but probably less liquid than money in a checking account.
long term: Long term refers to a period lasting more than a year. Bonds, pensions, and even vacation benefits are often long term items.
matching: Matching denotes comparing all revenues against all cost incurred to determine whether there are sufficient revenue to cover the costs. In business accounting the match is between all revenues earned and all cost incurred to produce the revenue. In accounting for government type funds and activities, the matching is likely to be based on legislating sufficient revenue to cover the all costs of that period. The cost could be actual outlays or promises or uses of assets. In this case, the matching is designed to assess intergenerational equity. For business, the matching is designed to calculate net profit or loss.
model: A model is an attempt to capture the important elements and relationship among the elements for a given issue or task. It is a simplification of reality.
modified accrual: Historically the committees and organizations that set the principles for governmental accounting have used the phrase modified accrual to characterize the rules for recognizing when to enter a transaction or event. Officially, modified accrual is used since accrual is used sometimes and cash sometimes. For example, a sales tax might be recognized on a cash basis, that is, when the tax is collected. Property tax might be accrued, that is, recognized when the legislature set the rates and the first day of the fiscal year began rather than when the tax money came in from the property levy.
notes to the financial statements: The notes are consider integral to financial statements. The statements themselves are a quantitative presented; the notes are usually verbal elaborations, although notes can be numerical in nature. Notes explain or expand on the financial statements. For example, the notes may explain a change in accounting policy or sick leave and vacation policy.
Off balance sheet: This term refers to efforts by accounting units to keep obligations off the financial statements. If an action by an accounting unit is handled so it is not recorded in the financial statements then it has no impact on the statements. Ordinarily, the action is a liability that the unit try to keep off the financial statements, or specifically the balance sheet. Off balance sheet financing is common in government since the financial statements are designed to essentially capture annual, not long term items. For example, a building that was financed by long term borrowing would not create a liability in the funds until the interest and principle were due. If the principle were not due for five years then the funds would not show the liability until that time.
primary government: A primary government is usually a state or general purpose government. It can also be a special purpose body that has an elected body. It is distinguished by having elected officials responsible and accountable to the people. principle amount: When bonds or other debt securities are sold, there is usually a principle amount, or the amount to be paid at maturity. If a government borrows $5,000,000 then the principle amount is $5,000,000.
proprietary funds: The propriety funds are different in purpose from the government funds and designed to be like business financial reporting. In other words, matching and accrual accounting provides a guide for proprietary funds. Two types of proprietary funds are the internal service fund and the enterprise fund.
rating agencies: A number of companies assign a risk level to the bonds or debt issued by a government. Risk means the likelihood of default or nonpayment. The lower the risk of nonpayment, the lower the interest the government must pay. Some rating agencies give a AAA rating to the least risky government bonds.
reinventing government: This term has been used by the new reformers who believe in government but feel government is too rule bound. These reformers looks to a government that has less rules and is more competitive. They are like the reformers of the turn of the 20th century in that they have faith in government. However, their thrust is efficiency through more competition not breaking boss rule and corruption through detailed rules.
schedules: Schedules also presented data in greater detail than it is presented in the financial statements. statistical tables: Presents comparative data, often for ten year periods and can include property values and population data.
success: Financial success goes with the operating statement or operating results. It is measured by whether the government was able to raise enough money during a given period to cover its outlays. In government success is affected by annual and cash nature of the accounting rules. Inflows of money can include borrowing; outflow include only those due and payable, not those promised but not payable this period.
statement of revenues, expenditures, and changes in fund balance: This is statement is designed to measure the operating success or results of the period. In government, operating success is achieved is enough money is brought in to cover the money going out. Money in can include borrowing and money out can include transfers. In business, operating success is based on revenues in excess of expenses.
statement of revenues, expenditures, and changes in fund balance budget and actual: This statement is designed to determine whether the administration complied with the authorized legislative budget but comparing the actual with the budget.
statement of cash flows: Cash flow statements are part of the statements produced when government operates on business accounting rules. The cash flows show where the cash originated and where it was paid, showing also how the change occurred between the beginning and ending cash amounts.
subentities: Government, for a variety of reasons, may have many subunits that are accountable to a single or overarching unit. A main unit, called a primary unit, may form many other units to carryout specific tasks. A government may, for example, form a housing unit or recreation unit to operate these special functions. Formally these subentities are often called component units.
transactions and events: These are the activities that the government captures or records in order to produce financial reports. Transactions are usually activities or exchanges between the government and outsiders or exchanges among funds. Events are things that occur but are not immediately recorded. A employee earns salary or wages every minute on the job, but this event is only recorded at set times.
transfers: Since governmental financial statements are based on funds, there is often a transfer among the funds. For example, the general fund may transfer money to the debt service fund so that fund can pay interest due on bonds. Because funds are the main accounting entity in government no effort is made to eliminate any double counting among funds and produce a consolidated statement for the entire government.
variance: The variance often compares some standard with the actual. In government, the standard can be the budget. Thus, the effort in government is often to stay within the budget and to avoid unfavorable variances, that is, where the actual is out of line with the budget.

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