Question

4.            A government accounts for inventory on the purchases basis. Why must it offset its year?end inventory balance with an addition to fund balance?

5.            Governments are not required to accrue interest on long?term debt in governmental funds even if the interest is applicable to a current period and will be due the first day of the following year. Explain and justify the standards that permit this practice

Answer 1

Solution:-

4. A government accounts for inventory on the purchases basis. Why must it offset its year?end inventory balance with an addition to fund balance:-

If a government accounts for inventory on a purchases basis, then it charges inventory as an expenditure (and consequently reduces unassigned fund balance) upon purchase. It therefore does not recognize the inventory as an asset. If, at year-end, it reports the inventory as an asset, then it must offset the increase in assets with an increase in fund balance. If the offset were made to unassigned fund balance, the effect would be to add back to unassigned fund balance amounts deducted from it when the inventory was purchased. This adjustment would cause the inventory to be accounted for on a consumption basis. The offset to nonspendable fund balance indicates an amount of net assets that is not available forother purposes and is not in spendable form.

5. Governments are not required to accrue interest on long?term debt in governmental funds even if the interest is applicable to a current period and will be due the first day of the following year. Explain and justify the standards that permit this practice:-

[Revise GASBS 34 Codification instructions paragraph .107 as follows:] Section 1600, ?Basis of Accounting,? paragraph .118, indicates that most governmental fund expenditures are measurable and should be recorded when the related liability is incurred. The major exception to the general rule of expenditure accrual relates to unmatured principal and interest on general long-term debt. Governmental fund liabilities and expenditures for debt service on general long-term debt, including capital leases, generally should be recognized when due—that is, to the extent that portions of the debt mature during the reporting period. Financial resources usually are appropriated in other funds for transfer to a debt service fund in the period in which maturing debt principal and interest must be paid. Such amounts thus are not current liabilities of the debt service fund as their settlement will not require expenditure of existing fund assets. Further, to accrue the debt service fund expenditure and liability in one period but record the transfer of financial resources for debt service purposes in a later period would be confusing and would result in overstatement of debt service fund expenditures and liabilities and understatement of the fund balance. Thus, disclosure of subsequent-year debt service requirements is appropriate, but they usually are appropriately accounted for as expenditures in the year of payment. On the other hand, if debt service fund resources have been provided during the current year for payment of principal and interest due early in the following year, the expenditure and related liability may be recognized in the debt service fund.

[Revise current Codification paragraph .123 as follows:] Long-term Debt.5 The major exception to the general rule of expenditure accrual, stated in paragraph .118, relates to unmatured principal and interest on general long-term debt, which includes special assessment debt for which the government is obligated in some manner. Governmental fund liabilities and expenditures for debt service on general long-term debt, including capital leases, generally should be recognized when due—that is, to the extent that portions of the debt mature during the reporting period. Financial resources usually are appropriated in other funds for transfer to a debt service fund in the period in which maturing debt principal and interest must be paid. Such amounts thus are not current liabilities of the debt service fund as their settlement will not require expenditure of existing fund assets. Further, to accrue the debt service fund expenditure and liability in one period but record the transfer of financial resources for debt service purposes in a later period would be confusing and would result in overstatement of debt service fund expenditures and liabilities and understatement of the fund balance. Thus, disclosure of subsequent-year debt service requirements is appropriate, but they usually are appropriately accounted for as expenditures in the year of payment. On the other hand, if debt service fund resources have been provided during the current year for payment of principal and interest due early in the following year, the expenditure and related liability may be recognized in the debt service fund.