Finance 101

This Advisor column was originally published in June 2007.

Crucial decisions involving our cities/towns are made throughout the year but most particularly at budget time. It is during this time when elected officials will determine how to allocate the limited available resources to best provide services to their constituency.

In anticipation of the coming budget season, we thought a discussion on the characteristics that make “governmental” accounting unique would be helpful.

The private sector has two separate financial models: one for business enterprises and one for non-profit organizations. The public sector uses a single financial reporting model that bears similarities to the private sector models but is unique in many ways. The first is that governmental accounting is concerned with services rather than profit. Only when a city has its own utilities will attention turn towards a more profit-oriented model, and even then it is a modified business model that seeks to fully finance its operations through user fees and charges, rather than make a profit. Another factor is that governmental accounting is focused on “accountability,” which requires governments to answer to citizens for the actions they take and the services they provide.

These factors lead to another unique aspect of government accounting: the use of funds.

So what is fund accounting? The biggest surprise to newly elected officials often comes when they review financial information and find numerous “funds.” The largest corporations will report operations on just one balance sheet, providing all cash, sales, etc., but in the world of government accounting, funds are used to segregate resources related to specific activities. Each fund has a separate set of self-balancing financial records and financial reports are provided for each.

Cities often establish separate funds to segregate financial resources that are subject to regulations, restrictions, or limitations. This segregation provides fiscal and operational accountability for each fund. In Washington separate funds are required for streets, utilities, general operations and restricted revenue sources such as hotel/motel tax, and real estate excise tax.

During the course of a year there is typically a lot of discussion about the fund called the “general fund” (also known as the current expense fund). This fund encompasses the general operations and basic services provided by a city such as public safety (police, fire and building inspection), planning, parks and recreation and finance and administration. Transportation, while considered by most to be a “general” operation of the city, is required to have its own fund. Some functions of the general fund, such as finance and administration, are shared with other funds to reduce costs and increase efficiency.

Utility funds must be operated more along the lines of a business enterprise. Charges for services should cover all operating expenses plus debt plus reserves for future capital needs. The revenues received can be used only for the benefit of the utility.

This same concept applies to other restricted revenues like criminal justice and those restricted resources mentioned above. As you are reviewing the second quarter financials for your city or town, keep in mind that separate funds for these restricted revenue sources helps eliminate the possibility of co-mingling revenues and the chance of inappropriate use.

Fund accounting is one example of the unique nature of government finance. It provides accountability and serves as a tool to reflect the financial operations of the city. We will be presenting more information on this topic and other financial issues at the session entitled “Finance 101” at the AWC annual conference in Tacoma. Understanding the unique characteristics of governmental accounting will assist you in making informed decisions during the upcoming budget season.