The principles of accounting for a governmental unit are different than those of private business. A government’s financial statements are used to make social and political decisions, while the bottom line of private business financial statements is to (hopefully) show a profit. Americans have not found business accounting standards particularly useful for evaluating their governments’ financial activities and have turned instead to an accounting system which emphasizes the control of spending. The legal authority to spend in a governmental organization is the approved budget. Americans, as taxpayers, are not so inclined to allow their governments open discretion in deciding how to spend public money. Individual funds are established to account separately for resources affected by different types of spending restrictions.
There are three categories of funds that make up the financial records of a government entity:
There are five types of Governmental funds that are used to track the collection and expenditure of mandatory taxes. These funds generally have a budgetary focus and report on the current financial resources available. Another category of funds, known as are Proprietary funds, show the activities of the voluntary payments of goods and services like utilities and garbage pickup. The two Proprietary funds have more of an operations orientation, therefore business accrual accounting is used. Income, financial position, and cash flow statements are prepared. Fiduciary funds are the third category and they are used to temporarily hold resources on behalf of individual agencies. These include the employee pension fund, investments, scholarships, and potential transfers to Governmental funds.
Accounting for business entities using non-fund accounting principles spotlights the revenue and net income recognition principles. This is because the Securities and Exchange Commission (SEC) highly regulates these types of activities that millions of people in the U.S. and other countries rely on. These business principles define the rules for the compilation of three statements, rather than the eleven statements required for a government entity. The ability to analyze the government financial statements through such a format is important to those that vote in the leaders of the jurisdiction.
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