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Question 1
Choice of accounting principles may have significant economic consequences.
In preparing its budget proposals, a city’s budget committee initially estimated that total revenues would be $120 million and total expenditures would be $123 million. In light of the balanced budget requirements that the city has to meet, the committee proposed several measures to either increase revenues or decrease expenditures. They included the following:
- Delay the payment of $0.4 million of city bills from the last week of the fiscal year covered by the budget to the first week of the next fiscal year.
- Change the way property taxes are accounted for in the budget. Currently, property taxes are counted as revenues only if they are expected to be collected during the budget year. New budgetary principles would permit the city to include as revenues all taxes expected to be collected within 60 days of the following fiscal year in addition to those collected during the year. The committee estimates that the change would have a net impact of $1.2 million.
- Change the way that supplies are accounted for in the budget. Currently, supplies are recognized as expenditures at the time they are ordered. The proposal would delay recognition of the expenditures until they are actually received. The committee estimates a net effect of $0.8 million.
- Defer indefinitely $1.5 million of maintenance on city roads. Except as just noted with respect to supplies, the city currently prepares its budget on a near‐cash basis, even though other bases are also legally permissible. It prepares its year‐end financial statements, however, on an accrual basis.
- Indicate the impact that each of the proposals would have on the city’s (1) budget, (2) annual year‐end financial statements, and (3) “substantive” economic well‐being.
- It is sometimes said that choice of accounting principles doesn’t matter in that they affect only the way the entity’s fiscal “story” is told; they have no impact on the entity’s actual fiscal history or current status. Do you agree? Explain.
Question 2
Is fund accounting less appropriate for businesses than for not-for-profits?
A newly formed not‐for‐profit advocacy organization, the Center for Participatory Democracy, requests your advice on setting up its financial accounting and reporting system. Meeting with the director, you learn the following:
- Member dues can be expected to account for approximately 80 percent of the organization’s revenues.
- The organization plans to seek grants from private foundations to carry out research projects pertaining to various political causes.
- The center has already received a gift of $100,000. The donor specified that the funds are to be placed in investment‐grade securities and that only the income is to be used to support center activities.
- The center leases office space but owns its furniture, fixtures, and office equipment.
- The center has taken out a five‐year term loan of $100,000. Although the loan is not due until its term expires, the organization intends to set aside $17,740 each year with the prospect that, properly invested, these payments will provide the necessary $100,000.
Do you believe that the center should establish its accounting system on a fund basis? If so, why?
Assume you answered “yes” to question 1. What specific fund types do you think the center should set up? Explain.
Alternatively, suppose the center was a privately owned, profit‐oriented consulting firm that provided political advice to its clients. The firm would charge its clients a fixed fee each month in return for which they would receive periodic newsletters and the opportunity to meet with the firm’s partners. In addition, the firm expects to enter into contracts to carry out specific research projects for its clients.
Would you now recommend that the firm establish its accounting system on a fund basis (assuming, of course, that it would prepare its external financial reports in accordance with generally accepted accounting principles applicable to businesses)? Explain.
Question 3
Government activities may be less “profitable” than they appear.
A city prepares its budget in traditional format, classifying expenditures by fund and object. In 2010, amid considerable controversy, the city authorized the sale of $20 million in bonds to finance construction of a new sports and special events arena. Critics charged that, contrary to the predictions of arena proponents, the arena could not be fiscally self‐sustaining. Five years later, the arena was completed and began to be used. After its first year of operations, its general managers submitted the following condensed statement of revenues and expenses (in millions):
| Revenues from ticket sales | 5.7 |
| Revenues from concessions | 2.4 |
| 8.1 | |
| Operating expenses | 6.6 |
| Interest on debt | 1.2 |
| 7.8 | |
| Excess of revenues over expenses | 0.3 |
At the city council meeting, when the report was submitted, the council member who had championed the center glowingly boasted that his prophecy was proving correct; the arena was “profitable.” Assume that the following information came to your attention:
- The arena is accounted for in a separate enterprise fund.
- The arena increased the number of overnight visitors to the city. City administrators and economists calculated that the additional visitors generated approximately $0.1 million in hotel occupancy tax revenues. These taxes are dedicated to promoting tourism in the city. In addition, they estimated that the ticket and concession sales, plus the economic activity generated by the arena, increased general sales tax revenues by $0.4 million.
- The city had to improve roads, highways, and utilities in the area surrounding the arena. These improvements, which cost $6 million, were financed with general obligation debt (not reported in the enterprise fund). Principal and interest on the debt, paid out of general funds, were $0.5 million. The cost of maintaining the facilities was approximately $0.1 million.
- On evenings when events were held in the arena, the city had to increase police protection in the arena’s neighborhood. Whereas the arena compensated the police department for police officers who served within the arena itself, those who patrolled outside were paid out of police department funds. The police department estimated its additional costs at $0.1 million.
- The city provided various administrative services (including legal, accounting, and personnel) to the arena at no charge at an estimated cost of $0.1 million.
- The city estimates the cost of additional sanitation, fire, and medical services due to events at the center to be approximately $0.2 million.
Would you agree with the council member that the arena was fiscally self‐sustaining?
In which funds would the additional revenues and expenditures be budgeted and accounted for?
Comment on the limitations of both the traditional object classification budget and fund accounting system in assessing the economic costs and benefits of a project—such as the sports and special events arena.
What changes in the city’s budgeting and accounting structure would overcome these limitations? What additional problems might these changes cause?
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