Chapter 9

Granof & Khumawala-6e
Business-Type (Proprietary)
Chapter 9
Chapter 9
who is helping to lead the zero-waste movement in
the Southeast.
NY TIMES-Oct. 20, 2009
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"Nobody wants a landfill site anywhere near them,
including in rural areas. We've come to this
realization that landfill is valuable and we can't bury
things that don't need to be buried."
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Thought to Ponder: Chapter 9
o Enterprise Funds
o Internal Service Funds
• Accounting for Insurance Activities
• GASB 34, special problems of reporting proprietary
funds in government-wide statements
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• Why governments and NFPs engage in businesstype activities
• Distinguish between Proprietary and Governmental
• Proprietary Fund Accounting
• Two types of Proprietary Funds
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Learning Objectives
Proprietary Funds
• To compare benefits and costs of the business-type
activities of a government.
• Facilitates comparisons with private enterprises
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• Enhances management of activities in which goods
or services are provided on a cost-reimbursement
basis (i.e. on a user charge basis.)
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Reasons for use:
• to account for governmental entity’s ongoing
(continuing) operations and activities
Proprietary Funds
Two types of Proprietary Funds
B) Internal service funds:
• Provide services to other government departments.
• Example: City of Houston Health Benefit and Long-term
Disability funds.
• Both of these services predominantly benefit
governmental units rather than the general
public or businesses
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• Provide services to the general public.
• Example: City of Houston’s Airports (Bush, Hobby and Ellington
Field), George R. Brown Convention Center, Combined Utility
System (formerly called the water and sewer system), etc.
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A) Enterprise funds:
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GASB Statement No. 20, Accounting and Financial Reporting for
Proprietary Funds and Other Governmental Entities That Use
Proprietary Fund Accounting
• Funds are said to be nonexpendable (or revolving)
• focus on determining operating net income, changes in net
assets (or cost recovery).
• Full accrual basis
• Measurement focus on all economic resources is consistent
with GASB
• Recognize revenues as earned and expenses as incurred.
• Balance sheet recognition to both capital assets and long-term
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Proprietary Funds -Accounting
Proprietary Funds
Required Financial Statements
Similar to those for a for-profit entity:
• Statement of Net Position Assets (or Balance Sheet):
Assets – Liabilities = Net (Assets) Position
2) Restricted Net assets position
3) Unrestricted Net Assets position
Statement of Revenues, Expenses, and changes in Fund Net
Assets Position:
o Reconciles beginning and ending net assets
Statement of Cash Flows
o Prepared in conformity with GASB standards rather than FASB
o Include cash and cash equivalents (i.e., time deposits, marketable
securities, and other items readily convertible to cash)
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1) Net Investment in capital assets (net of related debt)
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Three categories of Net Assets
Proprietary Funds - Accounting Equation
2) Restricted Assets
(e.g., for payment of
debt service)
3) Net Investment in
Capital Assets, Net of
Related Debt
Recall this is the same classification of net
assets that is required under GASB 34.
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1) Unrestricted
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Assets - Liabilities = Net Position Assets
2) Restricted Assets
Definition: Assets whose use is restricted by
contractual agreements or legal requirements
• Ideally liabilities to be paid from restricted assets
should be reported separately from liabilities to be
paid from unrestricted assets.
• Net Assets – Restricted, should be reported in the
Equity section of the Statement of Net Position
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o Customer deposits of utilities, assets set aside for repayment
of revenue bond principal, reserves for maintenance of plant,
and funding of depreciation
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• Typical examples:
Statement of Cash Flows
Required for proprietary funds but not governmental funds
• Cash flows from operating activities
• Cash flows from financing activities
• Cash flows from investing activities
GASB Statement No. 9:
• Cash flows from operating activities
• Cash flows from NON-CAPITAL financing activities
• Cash flows from CAPITAL & RELATED financing activities
• Cash flows from investing activities
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FASB Statement No. 95 classifies cash transactions
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FASB (NFPs & publicly-traded companies)
GASB (Governmental entities):
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A) Enterprise Funds
Enterprise Funds
Accounts for services:
o Capital maintenance, Public policy, Management
control, Accountability
Examples: The City of Atlanta has two major and five non-major
enterprise funds. The City of New York has no enterprise funds, but
has a large number of specially created public benefit corporations.
On the other hand, High Point, North Carolina has six enterprise
funds, and City of San Francisco has eight enterprise funds (all
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• Possible reasons for use:
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1) provided to the general public on a user charge basis OR
2) where the governing body has determined that periodic
determination of revenues earned, expenses incurred, and/or net
income is appropriate.
Water and sewer (public utilities)
Gas and electric utilities
Mass Transportation systems
Airports (ex. Bush, Hobby, Ellington Field)
Toll roads and bridges (Sam Houston Toll way – Beltway
8, Harris County Toll Road)
Parking garages and lots (ex. Theater District parking
Golf courses (Hermann Park)
Landfill facilities
Liquor stores
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Common Types of Enterprise Funds
Accounting for Enterprise Funds
• Previously, GASB standards allowed proprietary funds two options:
1) Follow pronouncements of the FASB and its predecessors issued
before November 30, 1989, unless they conflict with a GASB
2) Follow all FASB and predecessor standards, both those issued before
and after November 30, 1989, unless they conflict with a GASB
standard *
* Note that GASB standards always take priority
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• MUST use enterprise funds if one of the following criteria is met:
1) Activity financed solely with revenue debt instead of governmental
obligation debt.
2) Costs of providing services recovered by fees and charges
3) Pricing policy are designed to recover costs from fees and charges
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GASB Statement No. 34 provides guidance on
business-type activities.
Enterprise Funds
Utility Plant - Construction in Progress
Q: Should an imputed amount equivalent to
Allowance for Funds Used During
Construction (AFUDC) is permitted both
by utility regulators and the FASB.
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A: Capitalizing an “equity” component of
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interest be capitalized if a utility’s own
funds are used for construction?
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Municipal Solid Waste Landfills
Municipal Solid Waste Landfills
Accounted for either in governmental or
enterprise funds
o If usage fees are charged then accounted for in enterprise funds.
o Closure & Post-closure costs include:
 Equipment installed and facilities constructed after the landfill
stops accepting waste (e.g. gas monitoring systems, ground
water monitoring wells.)
 Final Cover
 Monitoring & Maintenance
If accounted for in ENTERPRISE FUND:
o Governments must report (but need not actually fund) both:
 Expense &
 Liability related to Closure & Post-Closure costs.
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Fees must cover ALL costs (i.e. costs incurred before, during, and
after landfill accepts waste)
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If accounted for in GOVERNMENTAL FUND:
o Liability/Expense of post closure costs reported only in
government-wide statements.
o No expenditure shown in Fund Statements
--“Pay-as-you-go” basis
An EPA rule requires all municipal landfills to meet stringent location,
design, and operating requirements to minimize the potential for
environmental damage.
Operators must also provide financial assurance they can properly
close landfills when full and provide post-closure ground water
monitoring for 30 years after closure.
These stringent rules are designed to protect the environment from
irresponsible handling of hazardous materials
o Owners must estimate the current cost of hiring a qualified thirdparty to close the MSWLF and care for it for 30 years after closure
o Current Year Liability/Expense =
(Estimated total cost x Landfill capacity)
Total Landfill Capacity
- Amount recognized in the past
o Annual adjustments are made as estimates change from year to
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Municipal Solid Waste Landfills (Cont’d)
As with landfill costs, pollution remediation costs may be accounted
for in either governmental or enterprise funds.
• Governmental funds: only current outlays would be
recognized as expenditures; no long-term liabilities would be
• Enterprise funds as well as government-wide stmts: estimates of
costs to be incurred in the future would be reported as both
expenses and offsetting liabilities.
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Government can be held accountable for pollution cleanup costs
owing to a variety of circumstances. For example:
• A school district discovered mold or asbestos in one of its
• Toxic substances from an abandoned county dump seeped into a
nearby water supply
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These costs should be estimated and recognized as an expense
and liability when the government knows or has reason to
believe that a site is polluted, that it will be responsible for the
cleanup, and it can make reasonable estimates of the ultimate
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• Pre-cleanup activities such as site assessments, site
• Cleanup activities such as removal and disposal of pollutants
• Government oversight and enforcement-related activities
• Post-remediation monitoring
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Per GASB Statement No. 49 Accounting and Financial Reporting
for Pollution Remediation Obligations (November 2006), the
pollution remediation costs to be accounted for include those for:
Regulatory Accounting Practice (RAP)
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Miscellaneous Enterprise Fund
Enterprise Funds
Regulatory Accounting Principles (RAP)
Why is rate of return regulation necessary?
What types of entities are subject to rate of return regulation?
What do the rates that I see on my electric utility bill mean?
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What is rate of return regulation?
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FASB Statement No. 71 Accounting for the Effects of Certain Types
of Regulation issued in 1982, stipulated that revenues,
expenses and resources should be recognized in accordance
with the rules established by a regulator.
How is the revenue requirement established?
What happens after the revenue requirement is established?
Key RAP definitions
• Original cost: The (depreciated) cost to the first owner to
place the utility plant into public use
• Utility Plant Acquisition Adjustment: The difference between
the purchase price of a utility plant less the net original cost
of the plant on the seller’s books.
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FASB Statement No. 71 Accounting for the Effects of Certain
Types of Regulation issued in 1982, stipulated that
revenues, expenses and resources should be recognized
in accordance with the rules established by a regulator.
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Enterprise Funds
Regulatory Accounting Principles (RAP)
Enterprise Funds
Special Current Liabilities
Usually up-front deposits required to be made by builders to
provide all or part of the cost of connecting new structures to
utility lines. May or may not be refunded in part upon
2) Customer Deposits
Usually reported under the caption “Liabilities Payable from
Restricted Assets”
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1) Customers Advances for Construction
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In addition to the usual Accounts Payable and Accrued
Expenses, use two special current liability accounts:
Enterprise Funds Segment Information
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Summary operating data, including extent of intragovernmental subsidies, should be disclosed in the
notes for "major non-homogeneous enterprise
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When there are multiple enterprise funds
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B) Internal Service Funds
Internal Service Funds
that provide goods or services to other funds, departments, or
agencies within the same governmental unit or occasionally to other
governmental units on a user-charge or cost-reimbursement basis
Primary reason for use:
to gain efficiency in the government’s operations.
Examples: The City of Houston has two internal service funds; San
Francisco has four internal service funds (central shops fund,
finance, corporation reproduction fund, telecommunications and
information fund) whereas the City of New York has no internal
service funds.
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Account for activities:
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Internal Service funds are an accounting device used to
accumulate and allocate costs internally among the
governmental entity’s various departments/units/functions.
Central purchasing
Issuance of supplies
Self-insurance pools
Central data processing
Electronic Equipment maintenance
Transportation (ex. Motor pools)
Central Post office
Central Telephone exchange
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Common Types of Internal Service
Accounting for Internal Service Funds
Internal Service Funds . . .
• are accounting entities
Must follow all FASB pronouncements issued prior to Nov. 30th
1989 unless it conflicts with GASB pronouncement (like
enterprise fund).
The GFOA recommends that every state or local government
establish clear criteria for whether an internal fund is classified
as a fund in the CAFR.
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• rarely have its resources restricted
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• are authorized by legislative approval
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• Full Accrual Basis
o Revenues derived mainly from other governmental or
proprietary funds.
o “Billings to Departments” is the revenue account that is
similar to “Sales” of a for-profit.
o Capital assets acquired by contributions or grants must be
• Revenues & expenses are closed at year-end to “Excess of
Net Billings to Departments over Costs” (or “Excess of Costs
over Net Billings to Departments”) rather than to Income
• Since the only “customer” of the internal service fund is the
government itself, the activity is presented in fund financial
statements, but eliminated for external facing reporting.
• The major fund requirements do not apply to internal service
funds because their balances are eliminated in the
government-wide financial statements
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Accounting for Internal Service Funds
o Can cover full costs (direct and indirect), direct
costs only, or whatever management desires.
o Full cost prices do not reflect cost of providing
incremental amounts of goods or services.
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• Pricing is set by local management or by
legislative policy
• Pricing objectives vary
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Pricing Policies for Internal Service
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Self Insurance
Example: City of Juneau, Alaska has a self-insurance fund to
account for the cost of administering the City and Borough’s
Risk Management Program.
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• Some governments elect to self-insure their risks.
o Reduces premiums
• Self insurance = NO INSURANCE (no transfer of risks to
o It simply sets aside funds to provide for possible losses
based on an actuarially determined amount.
o Often a govt. that self-insures part (or all) of its risk also
centralizes its risk financing activities
o Either use the GF or the ISF to account for these activities
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Self-Insurance (Cont’d)
GASB standards require that an ISF be used for risk
management (self-insurance) pools of a government:
--The ISF should recognize claims expense and a related
liability when:
1) It is probable an asset has been impaired, a liability
incurred, or a claim will be asserted AND
2) Loss is estimable
Disclose other loss contingencies in the notes.
Insurance department acts as an independent insurance
Premium Payments by government to ISF:
o Only a portion is reported as expenditure by the
government (and revenue by the ISF).
o Excess is a nonreciprocal transfer.
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GASB-mandated use of an ISF
Duplicate reported expenses when closing books
Depreciation is transferred to other governmental
Detract from Objectivity of Financial Statements
Obscure Fund Balance Surpluses or Deficits
o surpluses/deficits can be transferred from
general fund to the internal service fund.
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o costs and revenues are reported twice within
the same set of financial statements.
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• Transfer ISF's assets to another fund which
will continue same activity
• Terminate activity and distribute assets inkind to another fund or funds
• Convert ISF's assets to cash and distribute
cash to another fund or funds
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Terminating an Internal Service Fund
Service Concession Arrangements (SCA)
airports, telecommunication networks etc.
• The government transfers to the contracted party the right and
related obligation to provide services through the use of
infrastructure or other public asset.
• In exchange the government receives from the other party an upfront payment or a series of payments over time.
• GASB standards dictate that government spread any gains from
the transfer of the assets over the term of the contract.
• Governments enter into these agreements because they provide
quick and easy source of cash. In essence these agreements are
the economic equivalent of borrowing transactions.
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• SCA are long-term arrangements in which a government contracts
with a private sector entity or another government to operate a
major capital asset for example: toll roads, hospitals, student housing,
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GAAP is GASB Statement No. 60, “Accounting and
Financial Reporting for Service Concession
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• Revenue Bonds are backed by specific revenue
streams such as dedicated taxes or user charges.
• Business-type activities of governments are often
supported by revenue bonds
• Revenue Bonds are also issued by not-for-profit
entities including healthcare organizations,
universities and museums.
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Revenue Bonds
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Business-type Activities
Component Units?
Component Units (CU)
(1) PG appoints a voting majority of unit’s governing body
(2) A majority of unit’s governing body is composed of PG’s officials
(3) The PG is able to “impose its will” upon the unit
(4) Unit can cause the PG financial benefits or burdens
• If it meets these criterion, then unit is a CU of PG.
• Two Presentations of CU
(1) Blended – CU consolidated with PG in government-wide
--Presented this way if CU “provides services exclusively or almost
exclusively for the city” (examples in City of Houston CAFR)
(2) Discrete – CU shown in a separate column in government-wide
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• Entities that are economically intertwined with the government albeit
legally separate
• Criteria to determine whether a primary government (PG) is financially
accountable for another government.
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• The main reason for discussing CU in Ch. 9 is that some cities
will carry out these activities as CU and some will do it as part of
EFs. The main difference is the legal structure. CU are
separate legal entities.
Proprietary funds (internal service and enterprise) are used to
account for the business-type activities of a government
Accrual accounting is used for proprietary funds and the required
financial statements are the same as those for a for-profit entity,
except that GASB standards must be used where they apply
ISF are reported as governmental activities on the governmentwide statements
Regulatory accounting terminology and principles are used by
some government owned utilities
Service Concession Arrangements are long-term arrangements in
which a government contracts with a private sector entity or
another government to operate a major capital asset.
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Chapter 9
Business –Type Activities

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