Question

What changes in the city’s budgeting and accounting structure would overcome these limitations? What additional problems might these changes cause?

Government activities may be less “profitable” than they appear.

A city prepares its budget in traditional format, classifying expenditures by fund and object. In 2010, amid considerable controversy, the city authorized the sale of $20 million in bonds to finance construction of a new sports and special events arena. Critics charged that, contrary to the predictions of arena proponents, the arena could not be fiscally self‐sustaining. Five years later, the arena was completed and began to be used. After its first year of operations, its general managers submitted the following condensed statement of revenues and expenses (in millions):

Revenues from ticket sales	5.7
Revenues from concessions	2.4
	8.1
Operating expenses	6.6
Interest on debt	1.2
	7.8
Excess of revenues over expenses	0.3

At the city council meeting, when the report was submitted, the council member who had championed the center glowingly boasted that his prophecy was proving correct; the arena was “profitable.” Assume that the following information came to your attention:

• The arena is accounted for in a separate enterprise fund.

• The arena increased the number of overnight visitors to the city. City administrators and economists calculated that the additional visitors generated approximately $0.1 million in hotel occupancy tax revenues. These taxes are dedicated to promoting tourism in the city. In addition, they estimated that the ticket and concession sales, plus the economic activity generated by the arena, increased general sales tax revenues by $0.4 million.

• The city had to improve roads, highways, and utilities in the area surrounding the arena. These improvements, which cost $6 million, were financed with general obligation debt (not reported in the enterprise fund). Principal and interest on the debt, paid out of general funds, were $0.5 million. The cost of maintaining the facilities was approximately $0.1 million.

• On evenings when events were held in the arena, the city had to increase police protection in the arena’s neighborhood. Whereas the arena compensated the police department for police officers who served within the arena itself, those who patrolled outside were paid out of police department funds. The police department estimated its additional costs at $0.1 million.

• The city provided various administrative services (including legal, accounting, and personnel) to the arena at no charge at an estimated cost of $0.1 million.

• The city estimates the cost of additional sanitation, fire, and medical services due to events at the center to be approximately $0.2 million.

Answer 1

To find out the actual benefit from the arena, we make these adjustments to the revenue/expense statement :

Excess of revenue over expenses	300,000
Add : Additional hotel occupancy tax revenues	100,000
Add: increased general sales tax reveues	400,000
Less : Principal and interest on debt	(500,000)
Less : Cost of maintaining facilities	(100,000)
Less: additional costs of police department	(100,000)
Less : Administrative services to arena	(100,000)
Less : cost of additional sanitation, fire, medical services	(200,000)
Net Amount	(200,000)

We can see that after the adjustments, the net benefit is negative.

To overcome these limitations, the city's budgeting and accounting structure should have these changes :

• Identify the various cost centers in the city
• The expenses incurred by the city on behalf of various cost centers (such as arena, and other relevant cost centers) needs to be allocated to each cost center regularly on a logical basis.
• Revenues generated by cost centers need to be apportioned to the cost centers
• Administrative services provided by the city to cost centers need to be charged appropriately

These changes could cause these problems :

• More time and resources spent on accounting. This is an increase in administrative cost
• Deciding the reasonable basis for apportionment of costs/revenues to cost centers could become very complicated
• Bureaucratic problems such as departmental conflicts and disputes could increase