City Assets and Liabilities

“For profit” corporations are interested in monitoring and managing liquidity which refers to how quickly an asset can be converted to cash (a three-month treasury note is probably more liquid than a water tower but less liquid than money in a checking account), solvency (refers to ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth) and profitability which refers to the residual assets after liabilities have been paid and is referred to as net worth. Corporations use an accounting equation to monitor the performance of these areas. The accounting equation A=L+E, where A stands for assets, L for liabilities, and E for equity, is a simple algebraic equation and a great technique for describing an economic unit and keeping track of its financial performance. This equation can be used at the beginning and end of an accounting cycle to show the business’s financial status and change in financial performance.
This equation communicates the central elements of an economic operation. In the equation, assets represents the resources of the unit (cash, buildings), liabilities are resources received from others that must be repaid (notes payable, accounts payable), and equity exhibits the contributions and distributions of owners (retained earnings, dividends).
Equity is a complex concept in that it includes results of operations and contributions and withdrawals of owners. The results of operations address whether revenues exceed or do not exceed expenses. Contributions are what the owners put in, hoping for a good return. Withdrawals are what the owners take out for themselves. The word equity is usually associated with business activities in that it connotes ownership. For example, the accounting equation can be rearranged in the form of:
A - L = E
Equity is a residual interest after all the liabilities have been taken out or paid by existing assets. The residual equity belongs to the owners. Equity is sometimes called net worth or how much a business is worth (on the books, not on the market) after paying all the liabilities. All private sector businesses set out to increase equity and profit/net income.
Most municipal activities, however, function quite differently than private sector businesses. First, municipal activities are not undertaken to achieve a profit. They provide needed services that are not effectively provided by the private sector because the optimal quality and quantity are difficult to measure. Second, the activities provided have no direct relationship between the benefits received and the taxes paid. Finally, participation in municipal activities and taxes is involuntary.[1]
Generally, municipal accounts are organized on the basis of funds and account groups, each of which is considered a separate entity. The operations of each fund are accounted for with a separate set of self-balancing accounts that comprise its assets, liabilities, fund equity, revenue, and expenditures, or expenses, as appropriate. The various funds are grouped into five generic fund types and three broad fund categories. These broad fund categories consist of governmental funds, proprietary funds and fiduciary funds. This report will focus on the governmental funds.
Municipal governmental funds are divided into three categories.[2] The General Fund is the general operating fund of the municipal. It is used to account for all the financial resources except those required to be accounted for in another fund. Special Revenue Funds (Special Assessment, CableTV, etc) are used to account for the proceeds of specific revenue sources (other than expendable trusts or major capital projects) that are legally restricted to expenditures for specific purposes. Capital Project Funds (TID) are used to account for financial resources to be used for the acquisition or construction of major capital facilities (other than those financed by proprietary funds and trust funds). Most funds are established by governing bodies (such as state legislatures, municipal councils, or school boards) to show restrictions on the planned use of resources or to measure, in the short term, the inflows and outflows arising from certain activities.
The municipal governmental fund method of accounting designates any generated municipal equity as a fund balance. With governmental fund accounting, the accounting equation is somewhat different from that used in business. For governmental funds, the equation takes the form: CA = CL + FB Current assets = Current liabilities + Fund balance[3]
Essentially the equation is comparable to that of the equation for businesses, although two changes are made. (1) Equity is changed to fund balance. Equity connotes ownership and, in government, citizens do not own any of the excess that might accumulate. Thus, fund balance is used to measure inflows over or under outflows. The balance, if positive, is what can be appropriated for later spending. The term fund is used since the equation relates to each individual governmental fund, not the government as a whole. As noted, if the inflows are greater than the outflows, then the fund has a surplus for the period and the legislature can authorize how it is to be used in the next period. Inflows and outflows are used instead of just revenues and expenditures since fund balances can actually be increased by borrowing, whereas equity in business cannot be increased by borrowing. (2) Notice also, the focus of the equation for governmental funds is on current assets and current liabilities since governmental funds revolve around annual budgets or annual appropriations. In governmental funds, items that go beyond a year are placed outside the funds, in account groups.
Assets have been divided into two main groups, expendable and capital. Expendable assets are cash, investments, supplies, and accounts payable that are all short term. Capital assets are land, buildings, and equipment which is all items not expected to become available for spending in the short term. When accountants are reporting both short and long term assets, they call it the economic resources measurement focus. When they are reporting only the current assets and liabilities, they call it the current financial measurement focus. When municipal accountants are using the economic resources measurement focus, they will report net assets (A – L = NA) and when they refer to the current financial measurement focus they will report the fund balance (CA – CL = FB).
[1] Gauthier, Stephen J. Government Accounting, Auditing, and Financial Reporting. Chicago, IL: Government Finance Officers Association, 2001.
[2] City of Lake Mills Financial Reports, Hawkins, Ash, Baptie and Company, 2006.
[3] Definitions and Elements of Financial Reporting. Sacco, John Dr. 29/04/1999. George Mason University. 11/10/2007. .