Chapter One

Overview of Financial Reporting for Governmental and NFP Entities

Accounting and financial reporting for governments and nonprofit organizations are based on distinctive
concepts, standards, and procedures designed to accommodate their environments and the needs of their
financial report users.
Characteristics and Types of G&NP Organizations
Governments and other nonprofit organizations are unique in that:
 They do not attempt to earn a profit − and most are exempt from income taxes − so typical
business accounting, income tax accounting, usually is not appropriate.
 They are owned collectively by their constituents; and because ownership is not evidenced by
equity shares that can be sold or traded, residents who are dissatisfied with their government must
await a change in its elected governing body or move elsewhere.
 Those contributing financial resources to the organizations do not necessarily receive a
direct or proportionate share of their services. For example, homeowners pay property taxes to
finance public schools even if they do not have children in school or the welfare recipient
(probably) did not pay the taxes from which welfare benefits are paid.
 Their major policy decisions, and perhaps some operating decisions, typically are made by
majority vote of an elected or appointed governing body − for example, a state legislature, a
city council, or a hospital board of directors − whose members serve part time, receive modest or
no compensation, and have diverse backgrounds, philosophies, capabilities, and interests.
 Decisions usually must be “in the sunshine” − is meetings open to the public, including the news
media − and most have “open records” laws that make their accounting and other records open to
the public.
The major types of government and nonprofit organizations may be classified as:
1. Governmental: federal, state, county, municipal, township, village, and other local
governmental authorities and special districts.
2. Educational: kindergarten, elementary and secondary schools, vocational and technical schools,
and colleges and universities.
3. Health and welfare: hospitals, nursing homes, child protection agencies, the American red
Cross, and United Service Organizations (USO)
4. Religious: Young Men’s Christian Association (YMCA), Young Women’s Christian
Association (YWCA), Salvation Army, and other church-related organizations.
5. Charitable: United Way, Community Chest, and similar fund-raising agencies; related
charitable agencies; and other charitable organizations.
6. Foundations: private trusts and corporations organized for educational, religious, or charitable
G&NP organizations are similar in many ways to profit-seeking enterprises. For example:
1. They are integral parts of the same economic system and use financial, capital, and human
resources to accomplish their purposes.
2. Both must acquire and convert scarce resources into their respective goods and services.
3. Both must have viable information systems, including excellent accounting systems to assure that
managers, governing bodies, and others receive relevant and timely information for planning,
directing, controlling, and evaluating the sources, uses, and balances of their scarce resources.

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 4. Because their resources are scarce, cost analysis and other control and evaluation techniques
are essential to ensure that resources are utilized economically, effectively, and efficiently.
5. In some cases, both produce similar products. For example, both governments and private
enterprises may own and operate transportations systems, sanitation services, and electric or gas
utilities.
Difference between Business and Governmental and Not-for-Profit Entities
An understanding of how these organizations differ from business organizations is essential to
understanding the unique accounting and financial reporting principles that have evolved for
governmental and not-for-profit organizations. The major differences arise from different directions:
1) Organizational Objectives
≈ Objective of Business entities: To maximize the wealth and profit of their organization because
expectation of income or gain is the principal factor that motivates investors to provide resources to
profit-seeking enterprises.
≈ But the objective of most governmental and nonprofit organizations is to provide as much service
each year as their financial and other resources permit. In sum, private businesses seek to increase
their wealth for the benefit of their owners; G&NP organizations seek to expend their available
financial resources for the benefit of their constituency.

2) Sources of Financial Resources

The sources of financial resources differ between business and G&NP organizations, as well as among
G&NP organizations. In the absence of a net income objective, no distinction generally is made between
invested capital and revenue of G&NP organizations. A dollar is a financial resource whether acquired
through taxes, donations, user charges, sales of assets, loans, or some other manner.
The typical nondebt sources of financial resources for business enterprises are investments by owners
and sales of goods or services to customers. These sources of financing usually are not the primary
sources of G&NP organization financial resources.
3) Regulation and Control
The operation of most business enterprise is usually regulated by the market; i.e., the interaction of
demand and supply. In the business environment, there exist a direct relationship between the financial
resources each consumer provides and the goods or services that consumer receives from enterprise
essentially dictates the type and quality of goods or services each profit-seeking enterprise will provide.
Firms with responsive management will be profitable and will continue in the market. Firms with
unresponsive management will be unprofitable and ultimately will be forced out of business. Therefore,
the profit motive and profit measurement constitute an automatic allocation and regulating device in the
free enterprise segment of our economy.
This profit test/regulator device is not present in the usual G&NP situation, and most G&NP
organizations must strive to attain their objectives without its benefits. In addition, as noted earlier, many
G&NP organizations provide goods or services having no open market value measurement by which to
test consumer satisfaction. This problem exists because the goods or services are unique or are provided
to some or all consumers without charge, or at a token charge. Thus, these consumers have no “dollar
vote” to cast.
4) Ownership Interest
G and NP organizations are usually owned collectively by their constituents. Ownership is not evidenced
by equity shares that can be sold or traded. Because of this feature, there is no equity interest to be sold or

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traded. This implies that ownership interest is not clearly defined. In general, absence of defined
ownership interests that can be sold, transferred, or redeemed, or that convey entitlement to a
share of a residual distribution of resources in the event of liquidation of the organization
characterizes most G&NFP organization. But for profit seeking enterprises, ownership interest is
clearly defined which can be sold or traded or transferred to other parties. A business enterprise might
either be owned by a sole proprietor or partners or stockholders who they do have the right to sell or
transfer their ownership interest to other parties.
5) Cost-Benefit Relationship
Those contributing resources (donors or taxpayers) do not necessarily receive an equivalent or
proportionate share of the government`s or not-for-profit organization`s goods or services. Someone may
contribute more but may receive less or nothing. On the contrary, others may contribute less or nothing
but may earn more. For example, welfare recipient (probably) did not pay the taxes from which welfare
benefit are paid. However, there exist a direct relationship between costs and benefits in profit-seeking
organizations. This implies that those who are capable of afford (incur) more costs are entitled to get a
proportionate more benefits. Moreover, resource contributors (creditors and owners) can receive equity
interest in the net assets of the organization.

6) Scope of Operations
The scope of operation of G&NFP organizations, especially for governmental organizations, is mostly
diversifies. i.e., they are engaged in a wide area of activity. For example, consider the city municipality of
Hawassa. Its common operations cover health, security, administration, investments, construction, and
others. Relatively speaking, the operation or area of activity of profit-seeking organizations is more
specific. Based on their activity, we may categorize a given business entity in a service, a merchandising
or a manufacturing classification. Due to the above characteristics and characteristics, which would be
discussed in the subsequent sections, there is a need of complex accounting treatment for G&NFP
organizations as compared to profit-seeking organizations.
Sources of Financial Reporting Standards
Figure 1.1 shows the primary sources of accounting and financial reporting standards for business and
not-for-profit organizations, state and local governments, and the federal government. Specifically, the
FASB sets standards for for-profit business organizations and nongovernmental not-for-profit
organizations; the GASB sets standards for state and local governments, including governmental not-
for-profit organizations; and the Federal Accounting Standards Advisory Board (FASAB) sets
standards for the federal government and its agencies and departments.
Authority to establish accounting and reporting standards for not-for-profit organizations split between
the FASB and the GASB because a sizeable number of not-for-profit organizations are governmentally
owned, particularly public colleges and universities and government hospitals. The FASB is responsible
for setting accounting and reporting standards for the great majority of not-for-profit organizations, those
that are independent of governments. Governmental not-for-profit organizations follow standards
established by the GASB.

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 Comptroller General
Financial Director of the Office of
Accounting Management and
Foundation Budget
Secretary of the Treasury

Financial Governmental
Accounting Accounting
Standards Standards
Federal Accounting
Board (FASB) Board (GASB) Standards Advisory
Board (FASAB)

Nongovern-
Business State and local Governmental
mental
(for-profit) governmental not-for-profit
not-for-profit
organizations
organizations
organizations organizations Federal government
and its agencies and
departments

Users of Financial Reports

Users of G&NP entity accounting information are both internal and external. Major external users are:
 Resource provides (tax payers, donors and potential donors, investors and potential investors,
bond-rating agencies and grant providing organizations).
 Legislative and oversight bodies (higher-level governments and regulating agencies)
 Service recipients (citizen advocate groups)
Objectives of Financial Reporting
In its Concepts Statement No. 1, “Objectives of Financial Reporting,” the Governmental Accounting
Standards Board stated that “Accountability is the cornerstone of all financial reporting in
government….Accountability requires governments to answer to the citizenry  to justify the raising of
public resources and the purposes for which they are used.” The board elaborated:
… Governmental accountability is based on the belief that the citizenry has a ’“right to know,” a
right to receive openly declared facts that may lead to public debate by the citizens and their
elected representatives. Financial reporting plays a major role in fulfilling government’s duty to
be publicly accountable in a democratic society.

Closely related to the concept of accountability as the cornerstone of governmental financial reporting is
the concept the GASB refers to as interperiod equity. The concept and its importance are explained as
follows:
In short, financial reporting should help users assess whether current-year revenues are
sufficient to pay for services provided that year and whether future taxpayers will be
required to assume burdens for services previously provided.

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The concept requiring balanced budgets and those placing limitations on debt issuance, with the intent of
preventing the current generation of citizens from shifting the burden of paying for current-year services
to future-year taxpayers.
Table 1.1: Comparison of Financial Reporting O bjectives- State and Local Governments, Federal
Government, and Not-for-Profit Organizations
State and Local Governments Federal Government Not-for-Profit Organizations

Financial reporting is used in
making economic, social, and
political decisions and in assessing
accountability primarily to:
 Comparing actual financial
results with legally adopted
budget
 Assessing financial condition
and results of operations
 Assisting in determining
compliance with finance-related
laws, rules, and regulations
 Assisting in evaluating
efficiency and effectiveness
Financial reporting should help
to achieve accountability and is
intended to assist report users in
evaluating:
 Budgetary integrity
 Operating performance
 Stewardship
 Adequacy of systems and
controls
Financial reporting should provide
information useful in:
 Making resource allocation
decisions
 Assessing services and ability to
provide services
 Assessing management
stewardship and performance
 Assessing economic resources,
obligations, net resources, and
changes in them

Unlike the FASB and the GASB, which base their standards on external financial reporting, the
FASAB and its sponsors in the federal government are concerned with both internal and external
financial reporting. Accordingly, the FASAB has identified four major groups of users of federal
financial reports: citizens, Congress, executives, and program managers.
IPSAS versus IFRS
The International Public Sector Accounting Standards Board (IPSASB) develops accounting standards for
public sector entities referred to as International Public Sector Accounting Standards (IPSAS). The
standards of IPSASB are designed for public sector entities whose main objectives are to provide goods
and services to benefits the society and to re-distribute wealth. They are entities primarily financed by
taxation not the profit. IFRS (International Financial Reporting Standards) are internationally recognized
widely adopted and are designed for large profit oriented companies. The wide adoption brings about
consistency in financial statements that in turn facilitates cross border comparability and
understandability. This makes them particularly suitable for globally listed companies on stock
exchanges.

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 The Conceptual Framework for Public Sector Accounting

The objective of the IPSASB is to serve the public interest by setting high-quality public sector
accounting standards and by facilitating the adoption and implementation of these, thereby enhancing the
quality and consistency of practice throughout the world and strengthening the transparency and
accountability of public sector finances. The Conceptual Framework for General Purpose Financial
Reporting by Public Sector Entities (the Conceptual Framework) establishes the concepts that are to be
applied in developing International Public Sector Accounting Standards (IPSASs) and Recommended
Practice Guidelines (RPGs) applicable to the preparation and presentation of general purpose financial
reports (GPFRs) of public sector entities. The primary objective of most public sector entities is to deliver
services to the public, rather than to make profits and generate a return on equity to investors.
Consequently the performance of such entities can be only partially evaluated by examination of financial
position, financial performance and cash flows. GPFRs provide information to users for accountability
and decision-making purposes. Therefore, users of the GPFRs of public sector entities need information
to support assessments of such matters as:
 Whether the entity provided its services to constituents in an efficient and effective manner;
 The resources currently available for future expenditures, and to what extent there are restrictions
or conditions attached to their use;
 To what extent the burden on future-year taxpayers of paying for current services has changed;
and
 Whether the entity’s ability to provide services has improved or deteriorated compared with the
previous year.
Role of the Conceptual Framework

The Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities (the
Conceptual Framework) establishes the concepts that underpin general purpose financial reporting
(financial reporting) by public sector entities that adopt the accrual basis of accounting. The International
Public Sector Accounting Standards Board (IPSASB) will apply these concepts in developing
International Public Sector Accounting Standards (IPSASs) and Recommended Practice Guidelines
(RPGs) applicable to the preparation and presentation of general purpose financial reports (GPFRs) of
public sector entities.
Applicability of the Conceptual Framework

The Conceptual Framework applies to financial reporting by public sector entities that apply IPSASs.
Therefore, it applies to GPFRs of national, regional, state/provincial and local governments. It also
applies to a wide range of other public sector entities including:

 Government ministries, departments, programs, boards, commissions, agencies;

 Public sector social security funds, trusts, and statutory authorities; and
 International governmental organizations.

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Measurement Bases

It is not possible to identify a single measurement basis that best meets the measurement objective at a
Conceptual Framework level. Therefore, the Conceptual Framework does not propose a single
measurement basis (or combination of bases) for all transactions, events and conditions. It provides
guidance on the selection of a measurement basis for assets and liabilities in order to meet the
measurement objective. The following measurement bases for assets are identified and discussed in terms
of the information they provide about the cost of services delivered by an entity, the operating capacity of
an entity and the financial capacity of an entity, and the extent to which they provide information that
meets the qualitative characteristics:
 Historical cost;
 Market value;
 Replacement cost;
 Net selling price; and
 Value in use.
The following measurement bases for liabilities are identified:
 Historical cost;
 Cost of fulfillment;
 Market value;
 Cost of release; and
 Assumption price.
Financial Reporting of State and Local Governments
General Purpose External financial reporting
≈ General purpose external financial reporting (GPEFR) focuses on providing information to meet
the needs of financial report users.
≈ An objective of GPEFR is to provide users with information that will assist them in assessing the
performance of the reporting entity.
≈ Minimum requirements for general purpose external financial reporting under the governmental
financial reporting model specified by GASB Statement No. 34 (GASB 34).

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 ≈ MD&A is required supplementary information (RSI) designed to communicate in narrative, easily
readable form of the purpose of the basic financial statements and the government’s current
financial position and results of financial activities compared with those of the prior year.
≈ The MD&A should provide a narrative explanation of the contents of the CAFR, including the
nature of the government-wide and fund financial statements, and the distinctions between those
statements.
Comprehensive Annual Financial Report (CAFR)
Serious users of governmental financial information need much more detail than is found in the MD&A,
basic financial statements, and RSI (other than MD&A). For state and local governments, much of that
detail is found in the governmental reporting entity’s comprehensive annual financial report (CAFR).
Although governments are not required to prepare a CAFR, most do so as a matter of public record and to
provide additional financial details beyond the minimum requirements. As such the GASB provides
standards for the content of a CAFR in its annually updated publication Codification of Governmental
Accounting and Financial Reporting Standards. A CAFR prepared in conformity with these standards
should contain the following sections.

Introductory section
 Title page
 Contents page
 Letter of transmittal (a letter from the chief financial officer addressed to the chief
executive and governing body of the governmental unit)
 Other (as desired by management)

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Financial section
 Auditor’s report
represent minimum
 MD&A
 Basic Financial Statements requirements for general
 Required Supplementary Information purpose external
RSI (Other than MD&A)
 Combining the individual fund financial reporting
statements and schedules
Statistical section
In addition to the introductory and financial sections of the CAFR, A CAFR should contain a
statistical section. The statistical section typically presents tables and charts showing social and
economic data, financial trends, and the fiscal capacity of the government in detail needed by
readers who are more than casually interested in the activities of the governmental unit.
GASB Statement No. 44 indicates that generally the statistical section should present information
in five categories to assist the user in understanding and assessing a government`s economic
condition. The five categories are:
1) Financial trends information, which provides the user with information that is helpful in
understanding and assessing how a government`s financial position has changed over time. time.
Schedules in this category are prepared at both the fund level and government-wide level. The focus
is on showing the trend in fund balances and net asset categories, including changes in net assets and
fund balances.
2) Revenue capacity information, which assists the user with understanding and assessing the
government’s ability to generate its own revenues (own-source revenues), such as property taxes and
user charges. The schedules presented should focus on the governments most significant own-source
revenues. Suggested schedules provide information on the revenue base (sources of revenue),
revenue rates (including overlapping tax rate information), and property tax levy and collection
information.
3) Debt capacity information, which is useful in understanding and assessing the governments
existing debt burden and its ability to issue additional debt. Four types of debt schedules are
recommended−ratios of outstanding debt to total personal income of residents, information about
direct and overlapping debt, legal debt limitations and margins, and information about pledged
revenues.
4) Demographic and economic information, which assists the user in understanding the
socioeconomic environment in which the government operates, and provides information that can be
compared over time and across governments. Governments should present demographic and
economic information that will be most relevant to users, such as information on personal income,
unemployment rates, and employers.
5) Operating information, which is intended to provide a context in which the governments
operations and resources can be better understood. This information is also intended to assist users
of financial statements in understanding and assessing the government’s financial condition. At a
minimum, three schedules of operating information should be presented-number of government
employees, indicators of demand or level of service (operating indicators), and capital asset
information.