Chapter 9
Business-Type (Proprietary)
Activities
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Thought to Ponder: Chapter 9
"Nobody wants a landfill sited 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."
- JON D. JOHNSTON
of the EPA,
who is helping to lead the zero-waste movement in
the Southeast.
NY TIMES-Oct. 20, 2009
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Learning Objectives
 Why governments and NFPs engage in businesstype activities
 Distinguish between Proprietary and
Governmental activities
 Proprietary Fund Accounting
 Two types of Proprietary Funds
--Enterprise Funds
--Internal Service Funds
 Accounting for Insurance Activities
 GASB 34, special problems of reporting
proprietary funds in government-wide statements
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Proprietary Funds
Reasons for use:
 to account for governmental entity’s ongoing
(continuing) operations and activities
 Enhances management of activities in which
goods or services are provided on a costreimbursement basis (i.e. on a user charge
basis.)
 To compare benefits and costs of the
business-type activities of a government.
 Facilitates comparisons with private
enterprises
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Proprietary Funds
Two types Proprietary Funds
A) Enterprise funds:
 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.
B) Internal service funds:
 Provide services to other government departments.
 Example: City of Houston Health Benefit and Longterm Disability funds.
 Both of these services predominantly benefit governmental
units rather than the general public or businesses
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Proprietary Funds -Accounting Characteristics
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 longterm debt.
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Proprietary Funds
Required Financial Statements
Similar to those for a for-profit entity:

Statement of Net Assets (or Balance Sheet):
Assets – Liabilities = Net Assets
--Three categories of Net Assets
1) Invested in capital assets, net of related debt
2) Restricted Net assets
3) Unrestricted Net Assets

Statement of Revenues, Expenses, and changes in Fund Net Assets:
--Reconciles beginning and ending net assets

Statement of Cash Flows
--Prepared in conformity with GASB standards rather than FASB standards
--Include cash and cash equivalents (i.e., time deposits, marketable securities,
and other items readily convertible to cash)
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Proprietary Funds - Accounting Equation
Assets - Liabilities = Net Assets
1) Unrestricted 2) Restricted Assets 3) Invested in
Assets
(e.g., for payment of Capital Assets, Net
debt service)
of Related Debt
Recall this is the same classification of net
assets that is required under GASB 34.
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2) Restricted Assets
 Definition: Assets whose use is restricted by contractual
agreements or legal requirements
 Typical examples:
 Customer deposits of utilities, assets set aside for repayment of
revenue bond principal, reserves for maintenance of plant, and
funding of depreciation
 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 Assets.
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Statement of Cash Flows
Required for proprietary funds but not governmental funds
FASB (NFPs & publicly-traded companies)
vs.
GASB (Governmental entities):
FASB Statement No. 95 classifies cash transactions into:
 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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Enterprise Funds
 Accounts for services:
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.
 Possible reasons for use:
--Capital maintenance, Public policy, Management
control, Accountability
Examples: The City of Atlanta has two major and four 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.
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Common Types of Enterprise Funds
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Water and sewer (public utilities)
Gas and electric utilities
Mass Transportation systems
Airports (ex. Bush, Hobby, Ellington Field)
Ports
Toll roads and bridges (Sam Houston Tollway – Beltway 8, Harris
Cty)
Parking garages and lots (ex. Theater District parking garage)
Golf courses (Hermann Park)
Landfill facilities
Hospitals
Liquor stores
Lotteries
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Accounting for Enterprise Funds
GASB Statement No. 34 provides guidance on business-type activities.
 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
 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 standard
*
 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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Enterprise Funds
Utility Plant - Construction in Progress
Q: Should an imputed amount equivalent to
interest be capitalized if a utility’s own
funds are used for construction?
A: Capitalizing an “equity” component of
Allowance for Funds Used During
Construction (AFUDC) is permitted both
by utility regulators and the FASB.
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Municipal Solid Waste Landfills
Accounted for either in governmental or enterprise funds
 If usage fees are charged then accounted for in enterprise funds.

Fees must cover ALL costs (i.e. costs incurred before, during, and after
landfill accepts waste)
 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:
 Governments must report (but need not actually fund) both :
 Expense &
 Liability related to Closure & Post-Closure costs.
 If accounted for in GOVERNMENTAL FUND:
 Liability/Expense of post closure costs reported only in governmentwide statements.
 No expenditure shown in Fund Statements
--“Pay-as-you-go” basis
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Municipal Solid Waste Landfills

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
 Owners must estimate the current cost of hiring a qualified third-party
to close the MSWLF and care for it for 30 years after closure
 Current Year Liability/Expense =
(Estimated total cost x Landfill capacity)
________________________________ - Amount recognized in the past
Total Landfill Capacity
 Annual adjustments are made as estimates change from year to year.
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POLLUTION REMEDIATION COSTS
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 buildings
Toxic substances from an abandoned county dump seeped into a nearby water supply
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 recorded.
• 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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POLLUTION REMEDIATION COSTS (Cont’d)
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:




Pre-cleanup activities such as site assessments, site investigations,
Cleanup activities such as removal and disposal of pollutants
Government oversight and enforcement-related activities
Post-remediation monitoring
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 cost.
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Enterprise Funds
Special Current Liabilities
In addition to the usual Accounts Payable and Accrued
Expenses, use two special current liability accounts:
1) Customers Advances for Construction
 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 completion
2) Customer Deposits
 Usually reported under the caption “Liabilities
Payable from Restricted Assets”
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Enterprise Funds
Regulatory Accounting Principles (RAP)
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.
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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Enterprise Funds Segment Information
When there are multiple enterprise funds
 Summary operating data, including
extent of intra- governmental subsidies,
should be disclosed in the notes for
"major non-homogeneous enterprise
funds."
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Internal Service Funds
Internal Service funds are an accounting device used to
accumulate and allocate costs internally among the
governmental entity’s various departments/units/functions.
Account for activities:
-- 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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Common Types of Internal Service Funds
 Motor pools
 Central purchasing
 Storage
 Issuance of supplies
 Self-insurance pools
 Central data processing
 Printing
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Accounting for Internal Service Funds
Internal Service Funds . . .
 . . . are accounting entities
 . . . are authorized by legislative approval
 . . . rarely have its resources restricted
 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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Accounting for Internal Service Funds (cont.)
Accounting:
 Full Accrual Basis
--Revenues derived mainly from other governmental or proprietary funds.
--“Billings to Departments” is the revenue account that is similar to “Sales” of a forprofit.
--Capital assets acquired by contributions or grants must be depreciated.
 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 Summary
 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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Pricing Policies for Internal Service Funds
 Pricing is set by local management or
by legislative policy
 Pricing objectives vary
--Can cover full costs (direct and
indirect), direct costs only, or
whatever management desires.
--Full cost prices do not reflect cost of
providing incremental amounts of
goods or services.
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Question Number One (1)
Q: Assume that one of the government’s internal service funds was for
data processing services, for which the golf course was billed $30,000,
all of which was classified as “contractual services” in the golf course
fund. How would that amount be reported in the column for ISF? How
would it be reported in the government-wide financial statements?
A: Fund Statements: Billings of ISF would be reported as a revenue of
ISF and as an expense of the golf course. The related cost of providing
the service would be reported as an expense of the ISF.
Government-wide: Billings would be reported ONLY as an expense
of the golf course. The revenues and expenses of the ISF would be
eliminated in the consolidation process.
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Pregunta Número Dos (2)
Q: ISF reported $2.7 million in depreciation, an
amount that the government takes into account in
establishing the rates charged to other funds. How
would this charge be reflected in the governmentwide statements?
A: The depreciation charges are incorporated into the
amounts billed to the funds to which the ISF
provide services. Therefore, in the governmentwide, they would be incorporated into the expenses
of the functions accounted for in those funds.
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вопрос, номер три (3)
Q: In which column on the government-wide
statement of net assets—that for governmental
or business-type activities—is it most likely that
the assets and liabilities of the ISF would be
included?
A: Unless the ISF provides services mainly to
units accounted for in proprietary funds, their
assets and liabilities would be reported in the
column for governmental-type activities.
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问题第四 (4)
Legislative bodies are sometimes reluctant to
establish ISFs because they do not wish to let
purchasing occur outside the budget.
Q: Is this (budget) a real concern?
A: Even if an ISF is created for central purchasing and
sales of supplies, the legislative body still maintains
budgetary control over the expenditures made by
most departments and programs via the General
Fund and special revenues funds budgets.
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Self-Insurance
 Some governments elect to self-insure their risks.
--Reduces premiums
 Self insurance = NO INSURANCE (no transfer of risks to
outsider.)
--It simply sets aside funds to provide for possible losses based on an
actuarially determined amount.
--Often a govt. that self-insures part (or all) of its risk also centralizes
its risk financing activities
--Either use the GF or the ISF to account for these activities
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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Self - Insurance
GASB-mandated use of an ISF

GASB standards require that an ISF be used for risk management (selfinsurance) 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 company.
Premium Payments by government to ISF:
 Only a portion is reported as expenditure by the government (and
revenue by the ISF).
 Excess is a nonreciprocal transfer.
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PROBLEMS with ISFs
 Duplicate reported expenses when closing books
-costs and revenues are reported twice within the same set of
financial statements.
 Depreciation is transferred to other governmental funds
 Detract from Objectivity of Financial Statements
 Obscure Fund Balance Surpluses or Deficits
-surpluses/deficits can be transferred from general fund to the
internal service fund.
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Terminating an Internal Service
Fund
 Transfer ISF's assets to another fund which will
continue same activity
 Terminate activity and distribute assets in-kind to
another fund or funds
 Convert ISF's assets to cash and distribute cash
to another fund or funds
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Component Units (CU)
•
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.
•
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.
(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
statements
• Presented this way if CU “provides services exclusively or
almost exclusively for the city” (City of Houston CAFR)
(2) Discrete – CU shown in a separate column in government-wide
statements
•
•
•
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Business –Type Activities
Summary
 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
government-wide statements
 Regulatory accounting terminology and principles are
used by some government owned utilities.
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