Fund balance is an important measure that represents the difference between a fund’s assets and liabilities. The overall objective of fund balance reporting is to isolate that portion of fund balance that is unavailable to support the following period’s budget.
Because governmental funds’ measurement focus is the flow of financial resources, the balance sheet primarily reports assets and liabilities that represent net spendable and available resources for these funds. In many ways, fund balance represents working capital, which can either be used as a liquidity reserve or for spending in future years.
Many state and local governments are experiencing revenue shortfalls and are facing difficult decisions in balancing their budgets. One option some governments have is to use a portion of fund balance to offset revenue declines and balance the current-year budget. However, not all amounts reported as part of fund balance are available to be used in a future budget.
Under current practice, fund balances are either classified as reserved or unreserved. Many governments also designate part of unreserved fund balance. Recent research conducted by GASB shows a lack of consistency among governments in reporting the components of fund balance and that the components are often misunderstood by financial statement users. It is often unclear if any of the reserved or designated fund balances are available to help balance a government’s budget.
GASB Statement no. 54, Fund Balance Reporting and Governmental Fund Type Definitions, will significantly change how this information is reported. The statement is intended to improve the usefulness of the amount reported in fund balance by providing more structured classification. The statement also clarifies the definition of existing governmental fund types.
The purpose of this article is to assist governments and auditors in preparing for the reporting requirements of Statement no. 54 and to discuss possible policy changes governments should consider as they approach adoption of this statement, which is effective for periods beginning after June 15, 2010 (GASB encourages early implementation). In addition, it will help citizens and decision makers better understand the constraints placed on fund balances.
GASB’S SOLUTION
To improve the reporting of fund balance, a hierarchy of fund balance classifications has been created based primarily on the extent to which governments are bound by constraints on resources reported in the funds. This approach is intended to provide users more consistent and understandable information about a fund’s net resources.
The hierarchy of five possible classifications of fund balance is:
Nonspendable Fund Balance
- Amounts that cannot be spent due to form; for example, inventories and prepaid amounts. Also, long-term loan and notes receivables, and property held for resale would be reported here unless the proceeds are restricted, committed or assigned.
- Amounts that must be maintained intact legally or contractually (corpus or principal of a permanent fund)
Restricted Fund Balance
- Amounts constrained for a specific purpose by external parties, constitutional provision or enabling legislation. This is the same definition used by GASB Statement no. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments, for restricted net assets.
Committed Fund Balance
- Amounts constrained for a specific purpose by a government using its highest level of decision-making authority. It would require action by the same group to remove or change the constraints placed on the resources.
- Action to constrain resources must occur prior to year-end; however, the amount can be determined in the subsequent period.
Assigned Fund Balance
- For all governmental funds other than the general fund, any remaining positive amounts not classified as nonspendable, restricted or committed.
- For the general fund, amounts constrained for the intent to be used for a specific purpose by a governing board or a body or official that has been delegated authority to assign amounts. Amount reported as assigned should not result in a deficit in unassigned fund balance.
Unassigned Fund Balance
- For the general fund, amounts not classified as nonspendable, restricted, committed or assigned. The general fund is the only fund that would report a positive amount in unassigned fund balance.
- For all governmental funds other than the general fund, amount expended in
- excess of resources that are nonspendable, restricted, committed or assigned (a residual deficit). In determining a residual deficit, no amount should be reported as assigned.
Not all governments will have all five components of fund balance. Governments should review their current policies and procedures to determine if resources would meet the definition of committed or assigned. Additional policies may need to be adopted or revised to be consistent with the new definitions.
A number of policies discussed in this article may need to be adopted or revised under Statement no. 54. In addition, several new note disclosures are required (see sidebar, “Note Disclosures,” below).
Note Disclosures
Governments will be required to disclose more information about amounts reported in fund balance:
- Description of authority and actions that lead to committed and assigned fund balance.
- The government’s policy regarding order of spending regarding restricted and unrestricted fund balance and the order of spending for committed, assigned and unassigned.
- For any stabilization arrangements, the authority for establishing, requirements for additions, and the conditions under which amounts may be used. If not reported on the face of the financial statements, the stabilization balance.
- Description of any formally adopted minimum fund balance policies.
- The purpose of each major special revenue fund and which revenues or other sources are reported in each of those funds.
- Encumbrances, if significant, are reported in conjunction with other disclosures of significant commitments.
COMPUTING THE BALANCES
This may not be as easy as it seems. Total fund balance must be classified into one of the five possible categories described above at the end of each year. A government policy on the order in which resources are to be expended is an important factor in how amounts are reported in fund balance. Under Statement no. 34, governments were required to have a policy regarding whether it considers the use of restricted or unrestricted resources first when both are available for expenditure. This policy now applies at the fund level for restricted and unrestricted (committed, assigned or unassigned) resources.
Likewise a government should establish a policy on the order in which unrestricted resources are to be used when any of these amounts are available for expenditure. If a government does not establish a policy, the default approach assumes that committed amounts should be reduced first, followed by the assigned amounts, and then the unassigned amounts.
Governments must consider the impact on the components of fund balance when determining their policy on which funds are used first. Exhibit 1 (opens in a new window) reflects the results of two policies related to unrestricted resources. In Case A, the government elected a policy to use restricted amounts before unrestricted amounts. A policy was not elected on the use of unrestricted amounts; therefore, the default will be used where committed resources are used first. Under this approach, all of the ending fund balance is unrestricted and reported as either committed or assigned.
In Case B, the government elected a policy to use unrestricted amounts before restricted amounts. They also elected a policy to use assigned amounts before committed amounts. Under this approach, all of the ending fund balance is reported as restricted. The accounting policy choice on which resources are used first can significantly affect how balances are reported.
For most governments, determining the components of fund balance will be an annual exercise. The first step is to determine the amount that should be reported as nonspendable. For all but the general fund, the remaining amounts must be allocated to restricted, committed or assigned by reviewing the constraints placed on available resources and by applying the order of spending policy just discussed. Assigned fund balance is the residual classification after amounts have been classified as nonspendable, restricted or committed. However, if there is a negative balance after classifying amounts as nonspendable, restricted or committed, the fund would report a negative amount as unassigned. In this case no amount would be reported as assigned.
For the general fund, unassigned fund balance is the residual classification after amounts have been classified as nonspendable, restricted, committed or assigned. Only the general fund would report a positive amount as unassigned. A negative residual amount would be eliminated by reducing unassigned balance based on the government’s order of spending policy. No funds should report a negative amount for restricted, committed or assigned fund balance.
ENCUMBRANCES
For governments that use encumbrance accounting, encumbering funds that are already restricted, committed or assigned based on the source and strength of the constraints placed on them does not further limit the use of the amounts reported in these classifications. A government should not report amounts that are encumbered.
However, amounts encumbered for a specific purpose for which amounts have not been previously restricted, committed or assigned, should be classified as either committed or assigned, based on the criteria previously discussed for these two classifications. Significant encumbrances at year-end should be disclosed in the notes to the financial statements, along with other significant commitments.
STABILIZATION FUNDS
Some governments have stabilization funds to cover such things as revenue shortfalls, emergencies or other purposes. The authority to set aside resources often comes from a statute, ordinance or constitution. The formal action that creates these funds should identify and describe the specific circumstances under which these funds may be used. These circumstances should not be expected to occur regularly. Stabilization funds can be classified as either restricted or committed fund balance if they meet the criteria previously discussed. If the criteria of restricted or committed are not met, then stabilization agreements should be reported as unassigned.
REPORTING THE BALANCES
Governments can choose where to disclose information about constraints placed on the different classifications of fund balance. The information can be displayed on the face of the balance sheet, or only aggregate amounts can be reported with the constraints disclosed in the notes to financial statements.
For nonspendable fund balance, the amount not in spendable form and the amount that must be maintained intact must be disclosed separately. For restricted fund balance, major restricted purposes should be disclosed. Major specific purposes should also be disclosed on committed and assigned fund balance.
Exhibit 2 (opens in a new window) is from Appendix C of Statement no. 54. It provides an example of displaying the information about constraints on fund balance on the face of the financial statements and an example of only showing aggregate amounts for fund balance.
FUND DEFINITION
As part of the fund balance project, GASB determined that clarifying certain terms used in fund type definitions would improve consistency on how fund types are reported. This was a limited-scope approach to fund type definitions and is not intended to impose more restrictive interpretations on the use of the various fund types than the current standard. However, research shows that many governments are not following current standards, especially as they relate to special revenue funds.
The changes to the general fund, debt service fund and capital project fund definitions are minor and, in most cases, just reflect the new terms of restricted, committed and assigned included in this standard.
The changes to the special revenue fund definition included additional guidance on when resources should be reported in this fund. The definition of a special revenue fund is: “Special revenue funds are used to account and report the proceeds of specific revenue sources that are restricted or committed to expenditure for specific purposes other than debt service or capital projects.”
The standard says that the foundation for the fund should be from a revenue source that is either restricted or committed. That restricted or committed revenue source should be expected to continue to represent a substantial portion of the inflows reported in that fund. Other restricted, committed or assigned revenue may be reported in that fund. At any point the government does not expect that a substantial portion of the inflows will be from restricted or committed resources, the government should stop using a special revenue fund and report the remaining resources in the general fund.
This definition of a special revenue fund appears less restrictive than the current standard, but it may be more restrictive than what many governments are currently following in reporting resources in special revenue funds. Some special revenue funds may not meet the additional guidance requiring that a substantial portion of the future inflow come from a restricted or committed resource (see sidebar, “Audit Impact,” below).
Governments will want to determine if their special revenue funds meet the revised definition well ahead of their planned implementation of Statement no. 54. Some of the resources reported in special revenue funds may need to be reported in the general fund. Because the budget cycle for the general fund occurs several months before the beginning of the fiscal year, it is important to know where certain resources will be reported at the start of the budget process. For example, many June 30 fiscal year-end governments will begin work on their fiscal year 2011 (Statement no. 54 implementation year) budget this fall.
Audit Impact
An auditor must consider several things in preparing for an audit client under GASB Statement no. 54. He or she must review the client’s policies for the authority and actions that lead to committed and assigned fund balances, the order of spending, and the creation of governmental funds. The auditor needs to obtain assurance that the policies are properly documented, being followed, and are properly disclosed in the notes to financial statements.
The auditor will also need to conduct a review of current governmental funds, particularly special revenue funds. This review should include major and nonmajor funds.
In one test case, nearly one-third of a government’s special revenue funds did not appear to meet the revised special revenue fund definition (10 funds out of 31). For example, funds with residual balances, those that do not have a significant committed revenue source, and funds that receive most or all of their revenue as a transfer from another fund would likely not meet the revised definition for a special revenue fund. Special revenue funds that do not meet the revised fund definition should be reported as part of the general fund. For this government, reporting the funds as part of the general fund would have a material impact on the fund balance.
It is likely that the fund balance classification will be performed as a part of year-end financial reporting and recorded in a subsidiary ledger (spreadsheet). Controls should be established over this aspect of financial reporting and need to be documented and tested in accordance with current risk-based auditing standards.
EXECUTIVE SUMMARY
GASB Statement no. 54 establishes a hierarchy of fund
balance classifications
based
primarily on the extent to which governments are bound by
constraints placed on resources. Governments need to
consider several things before implementing this reporting
standard.
Statement no. 54 clarifies the definition of existing
governmental fund types.
Because
of the timing of the budget cycle, governments need to
assess early the impact of this statement on reporting
information for governmental funds.
Governments must determine if current special revenue
funds
meet
the revised fund definition for such funds. They should
establish a policy on the order in which unrestricted
resources are to be used when any of these amounts are
available for expenditure. Finally, governments should
review their current policies and procedures to determine
if resources would meet the definition of committed or
assigned.
Statement
no. 54 is effective
for
financial statements for periods beginning after June 15,
2010. GASB encourages early implementation.
Bruce W. Chase (bchase@radford.edu) is a professor of accounting and director of the Governmental and Nonprofit Assistance Center at Radford University in Virginia. John B. Montoro ( jmontoro@cbh.com) is a partner with Cherry, Bekaert & Holland LLP, in Richmond, Va.
To comment on this article or to suggest another article, contact Loanna Overcash, senior editor, at lovercash@aicpa.org or 919-402-4462.
AICPA RESOURCES
Publications
- State and Local Governments: Audit and Accounting Guide (#012669)
- State and Local Governments: Checklists and Illustrative Financial Statements (#0090309)
- State and Local Governmental Developments: Audit Risk Alert (#0224309)
For more information or to place an order, go to cpa2biz.com or call the Institute at 888-777-7077.
Governmental Audit Quality Center
The Government Audit Quality Center (GAQC) is a firm membership center that helps member firms achieve the highest standards in Yellow Book, not-for-profit, HUD or government audits through targeted e-mail alerts, resources and teleconferences. Visit the GAQC at aicpa.org/GAQC. For members, the Center has an archived conference call presented by GASB staff and titled “New GASB Fund Balance Standard: Now is the Time to Begin Talking to Your Clients,” available at tinyurl.com/l2ybv5.
