Chapter 9
Business-Type Activities
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Learning Objectives
 Why governments and NFPs engage in businesstype activities
 Distinguish between Proprietary and
Governmental activities
 Fundamental principles of Proprietary Fund
Accounting
 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 compare benefits and costs of the
business-type activities of a government.
-Enhances management of activities
in which goods or services are
provided on a cost-reimbursement basis
to departments of the same government
or to the general public on a user charge basis.
 Example: the city of Houston maintains two
different types of proprietary funds.
-Enterprise funds and Internal Service funds
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Proprietary Funds
Two types of funds are classified as proprietary:
 Internal service funds:
-Provide services to other government departments on a
user charge basis.
-Example: City of Houston Health Benefit and Longterm Disability funds.
 Enterprise funds:
-Provide services to the general public on a user charge
basis.
-Example: City of Houston’s Airports (Bush, Hobby and
Ellington Field), George R. Brown Convention Center,
etc.
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Proprietary Funds
Accounting Characteristics
 Governments:
-Full accrual basis
-Recognize revenues as earned and expenses as incurred.
-Balance sheet recognition to both capital assts and longterm debt.
 Not-for-profits:
-Full accrual basis
-Capital assets and long-term liabilities accounted for
within the funds.
-Resources are donor-restricted and classified per FASB
Statement No. 117
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Business-Type Vs. Governmental Activities
Business-type accounting used to account for
proprietary funds:
 Full accrual basis
 Measurement focus on all economic resources is
consistent with GASB
 Information on depreciation
 Facilitates comparisons with private enterprises
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Proprietary Funds
Required Financial Statements
Similar to those for a for-profit entity:

Statement of Net Assets (or Balance Sheet):
-Invested in capital assets, net of related debt
-Restricted Net assets
-Unrestricted Net Assets

Statement of Revenues, Expenses, and changes in Fund Net Assets:
-comparable to income statement of a business
-Reconciles beginning and ending net assets

Statement of Cash Flows:
-Required for proprietary funds but not
governmental funds
-Summarizes the entity’s cash account
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Statement of Cash Flows
FASB Statement No. 95 classifies cash transactions
into:




Cash flows from operating activities
Cash flows from financing activities
Cash flows from investing activities
This is not applicable to governments.
GASB Statement No. 9:




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Cash flows from operating activities
Cash flows from non capital financing activities
Cash flows from capital and related financing activities
Cash flows from investing activities
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Proprietary Funds
Accounting Equation
Assets = Liabilities + Net Assets
Unrestricted
Restricted
(e.g., for payment of
debt service)
Invested 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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Enterprise Funds
Enterprise funds are used to report the same functions
presented as business-type activities in the
government-wide financial statements.
Reasons for use
 Used to
-Account for services provided to the general public on a user charge basis
or where the governing body has determined that periodic
determination of revenues earned, expenses incurred, and/or net
income is appropriate
-For capital maintenance, public policy, management control,
accountability, or other purposes
The City of Houston uses enterprise funds to account for its
aviation system, combined utility system (formerly called
the water and sewer system), and the convention and
entertainment facilities.
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Common Types of Enterprise Funds
– Water and sewer (public utilities)
– Gas and electric utilities
– Transportation systems
– Airports (Bush, Hobby, Ellington Field)
– Ports (Port of Houston)
– Toll roads and bridges (Sam Houston Tollway – Beltway 8)
– Parking garages and lots (Theater District parking garage)
– Golf courses (Hermann Park)
– Hospitals (Ben Taub)
– Liquor stores.
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Accounting for Enterprise Funds
 GASB Statement No. 34 provides guidance on business-type activities:
 Use of enterprise funds when one of the following criteria is met:
 Activity financed solely with revenue debt instead of governmental
obligation debt.
 Costs of providing services recovered by fees and charges
 Pricing policy establishes fees and charges to recover costs
 Previously, GASB standards allowed proprietary funds two options:
 Follow pronouncements of the FASB and its predecessors issued
before November 30, 1989, unless they conflict with a GASB
standard
 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 – 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 assets should be reported in the
Equity section of the Statement of Net Assets.
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Enterprise Funds
Utility Plant - Construction in Progress
Q: Should interest incurred on debt during construction
be capitalized?
A: Yes.
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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Enterprise Funds
Special Current Liabilities
 In addition to the usual Accounts Payable and
Accrued Expenses, use two special current liability
accounts:
 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
 Customer Deposits
 Usually reported under the caption “Liabilities
Payable from Restricted Assets”
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Enterprise Funds
Regulatory Accounting Principles (RAP)
 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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Municipal Solid Waste Landfills
 Accounted for either in governmental or
enterprise funds
 If usage fees are charged—accounted for in
enterprise funds.
 Governments have to report both -- expense and
liability.
 Liability of post closure costs reported only in
government-wide.
 “Pay-as-you-go” basis
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Municipal Solid Waste Landfills (cont’d)

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
 Estimate the current cost of hiring a qualified third-party to
close the MSWLF and care for it for 30 years after closure
 Recognize a portion of this cost proportionate to the ratio of
estimated capacity utilized during a year over the total capacity
of the landfill as an expense of the enterprise fund and as a
liability
 Annual adjustments are made as estimates change from year to
year.
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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
 Used to account for services provided by governmental units to other
governments on a cost reimbursement basis.
 These funds are accounting entities.
 Promotes efficiency
 Usually accounted for in general fund or some governmental fund
 Authorized by legislative approval
 ISF resources are rarely restricted.
 Accounted for in general fund or other governmental fund.
 Reasons for use: Improve management of common resources by
placing them under centralized management and control
 The City of Houston uses internal service funds to account for health and
benefits and long-term disability activities.
– Because both of these services predominantly benefit governmental rather than
business-type functions, they have been included within governmental activities
in the government-wide financial statements.
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Accounting for Internal Service Funds

Revenues recognized when earned.

Expenses recognized on full accrual basis.

Derives revenues mainly from other governmental or proprietary
funds.

Accounting for both ISF & enterprise funds: must follow all FASB
pronouncements issued prior to Nov. 30th 1989 unless it conflicts with
GASB pronouncement.

Generally should use the same accounting procedures that a similar
for-profit entity would use. Billings to Departments is the revenue
account that is similar to Sales of a for-profit entity

Revenues and 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
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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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Internal Service Funds Financial Statements
 Other than the slight difference in
terminology, the financial statements are
essentially the same as those of a comparable
for-profit entity.
 Statement of Net Assets
 Statement of Revenues, Expenses, and Changes in
Net Assets
 Statement of Cash Flows - prepared in conformity
with GASB standards rather than FASB standards.
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Internal Service Funds Statement of Cash
Flows
 Similarities between GASB and FASB
standards:
 Cash Flows Statement shows cash
inflows/outflows relating to
operating, financing, and investing
activities
 Both sets of standards define cash
flows as cash and cash equivalents
(i.e., time deposits, marketable
securities, and other items readily
convertible to cash)
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Internal Service Fund—Illustration
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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Internal Service Funds
Capital Assets and Depreciation
 Depreciation of capital assets
acquired by contributions or grants.
 The issue is: should the ISF be able
to recover in its prices or rates a cost
it did not incur for such assets?
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ISF Illustration
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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ISF Example
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 provide 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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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.
 Legislative bodies are sometimes reluctant to
establish ISFs because they are do not wish to
let purchasing occur outside the budget.
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Internal Service Funds (cont’d)
Q: Is this a real concern?
 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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Internal Service Funds
 GASB-mandated use of an ISF
 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:
 it is probable that an asset has been impaired or a liability has
been incurred and the amount is reasonably estimable, or
 if an estimable loss has been incurred and it is probable that a
claim will be asserted
 Disclose other loss contingencies in the notes.
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ISF Accounting Procedures
 Critical Implications:
 Duplicate reported expenses:
 costs and revenues are reported twice within the same set of
financial statements.
 Transfer of depreciation to 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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Self-Insurance




Governments elect to self-insure their risks
Reduces portion of the premium
Accounted for in either general fund or ISF.
Insurance department acts as an independent insurance
company.
 Self insurance is no insurance: no transfer of risks to
outsider.
 It simply sets aside funds to provide for possible losses.
 Payments for self-insurance premiums:
 Only portion of the premium is reported as expenditure—this
amount is recognized as revenue in ISF.
 Excess is treated as a nonreciprocal transfer.
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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.
END
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