State and Local Governments Should Pay Close Attention to Fund Balance
Fund balance is one of the most important elements of your state or local government’s financial statements, yet many financial statement preparers report unclear and inconsistent information about it. Even with the helpful guidance published in GASB 54 (issued by the Government Accounting Standards Board in 2009), I still see many governments struggle or neglect to give fund balance its due attention.
It isn’t just for compliance that you should be concerned with getting this reporting right. Fund balance is important to a range of people using your financial statements, including creditors and municipal analysts, stakeholders such as taxpayers and citizens, and your own organizational management and governance. Your fund balance helps them:
- Assess the availability of your current financial resources.
- Identify potential resources that are available for interfund transfer.
- Research reserves.
- Understand the purposes for which resources have been committed and assigned, and the relative strength of those commitments.
- Determine the availability of funds for repayment of debt.
- Assess availability of funds for expansion or addition services.
- Evaluate salaries.
- Make tax rate adjustments.
Let’s take a closer look at each user group’s reliance on accurate fund balance information and the errors many governments make in reporting it.
Municipal analysts use fund balance to rate your credit
Moody’s rating methodology currently assesses fund balance as a percentage of revenue, and the five-year change in fund balance as a percentage of revenue, in its credit factor. Analysts place a significant emphasis on fund balance reserves, as well as your municipality’s policies on reserves.
The recent recession has shown how a decline in tax revenues can impact budgets — and how reserves can be used to steady the ship in uncertain times. Your rating strength typically depends on how large your reserve balances are in comparison to your government’s revenue sensitivity. If you have high revenue-raising flexibility, you are allowed to carry lower reserves.
Rating agencies typically focus on assigned and unassigned general fund balance but review for any funds that may be used for operations. Overall, an analyst’s focus on fund balance is not a one-size-fits-all approach; it’s more an assessment of how well you use favorable times to prepare for a downturn and ensure fund availability for debt payment.
Taxpayer advocates use fund balance to judge your financial stewardship
Although saving for a rainy day may seem like a prudent financial policy, there are many organizations that review your government’s financial statements to make sure you are not overcharging and overtaxing. These taxpayer and citizen watchdog groups typically want to know the appropriate level of unassigned fund balance.
The Government Finance Officers Association has a best practice recommendation that, “at a minimum, general-purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures.”
Fund balance reserves greater than this recommended amount may put a target on your government’s back. Taxpayer and citizen advocacy groups may assert those reserves should be in the pockets of taxpayers rather than in the hands of management. They will support statutory limits on the amount of reserves a government can accumulate.
Management and governance use fund balance in budget planning
Your own organization’s management and governance should pay particular attention to fund balance during the budget process. Budgeting is typically an exercise that helps to balance current-year revenues against expenditures; however, management may need fund balance to close these deficits, which could be a cause for concern.
Utilizing fund balance to pay for increases in operating expenses may point to a structural problem, which could further indicate significant future changes in your operations. Your management may also review fund balance to look for accumulated surpluses to pay down debt, fund capital projects, or pay for one-time expenditures that could produce long-term saving or generate value for your entity.
Common errors in fund balance reporting
GASB 54 requires fund balance to be displayed in five categories. The reporting errors I typically encounter are within those categories.
Nonspendable fund balance
Long-term amount of loans and notes receivable should be included in nonspendable fund balance unless the proceeds from their collection are restricted, committed, or assigned.
Restricted fund balance
There are three reasons why restricted fund balance on your governmental funds may not equal the government-wide statement of net position:
- The principal amount of a permanent fund is classified as nonspendable fund balance in your governmental fund financial statements but is included in restricted net position in the government-wide statement of net position.
- Reconciling items that represent basis of accounting differences may cause the amounts to be different.
- Internal service fund net position is generally included with governmental activities.
Any funds required as a match for a grant should be reported as restricted fund balance as they are bound by the same constraints.
Committed fund balance
In order to report a stabilization fund as committed, the arrangement has to be specific enough to identify non-routine circumstances when the funds can be spent.
Assigned fund balance
A negative balance should not be reported for restricted, committed, or assigned fund balance in any fund. Encumbrances should not be displayed on the face of your governmental financial statements, as executing a contract is an act that assigns funds for a specific purpose. At a minimum, that should be reported in assigned fund balance.
Unassigned fund balance
The only fund that should report a positive unassigned fund balance is the general fund.
How we help
CLA’s state and local government professionals are deeply familiar with the requirements of GASB 54. We can help you understand, interpret, and report fund balance information so that it is both compliant and informative to your financial statements’ users.