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Taking charge of your fund structure: the use of unnecessary funds in external financial reports needlessly adds to the length and complexity of these reports and can increase audit fees. The City of Westlake, Ohio, has developed a policy to ensure that superfluous are not included in the CAFR.

Generally accepted accounting principles define fund as a "fiscal and accounting entity with a self-balancing set of accounts ... which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations." (1) Historically, funds were the defining feature of governmental accounting and were used to control restricted resources and demonstrate compliance. While there has never been a limit on the number of individual funds a government may use, the number of funds principle holds that a government should use the least number of funds possible.

GASB 34 has forced governments to rethink the role of funds in governmental accounting. The focus of government financial reporting is now divided between fund financial statements and the new government-wide financial statements, and the principal role of funds is to demonstrate accountability. (2) Recognizing the need for additional guidance on the use and number of funds under the new model, GFOA in March 2004 adopted a recommended practice entitled "Improving the Effectiveness of Fund Accounting."

This recommended practice makes a distinction between the use of funds for the purpose of internal accounting and the classification of funds for the purpose of external financial reporting. "GFOA recommends that every state and local government that uses fund accounting establish clear criteria for determining whether a given internal 'fund' should be classified and reported as an individual fund in the government's comprehensive annual financial report." The practice goes on to state that wherever possible similar internal funds should be combined into a single fund for the purpose of external financial reporting and that governments should periodically review the fund structure to ensure that superfluous funds are not included in the CAFR.


Around the time the recommended practice on funds was approved, the City of Westlake, Ohio, was confronting an all too common problem among municipalities, especially in Ohio--a complex web of funds used for accounting and financial reporting. Even though the finance department had eliminated and combined a number of funds during the conversion to new financial accounting software in 2003, the city still lacked a clear methodology for determining whether or not to create a new fund. After reviewing the recommended practice, the city decided to develop a policy on the use of funds. The policy that emerged established criteria for creating a new fund, classified funds for the purpose of financial reporting, and mandated periodic review of the fund structure.

Creating New Funds. By 2004, Westlake had nearly 100 individual funds--a number that would soon be reached unless the city did something. Some of these funds were created to account for individual grants and other revenue sources as required by the grantor or oversight agency. Others were created to account for various donations, capital projects, and other special revenues. The large number of funds used by the city added to the length and complexity of the CAFR, thus undermining this document's usefulness to important stakeholders.

To control the number of funds, the city decided to impose standards on the creation of new funds. If the state or federal government requires a separate fund to account for a particular source of revenue, then such a fund can and must be created. If there is no such requirement, however, three of the following six criteria must be met:

* Is the revenue source ongoing (more than one fiscal year)?

* Are the amounts material?

* Is interest required to be individually allocated?

* Are the amounts specially designated?

* Is there another fund that can be used to account for the revenue source?

* Are there special circumstances that have led management to create a separate fund?

All new funds must be created by City Council ordinance.

Financial Reporting Guidelines.

After establishing the criteria by which new funds are created, it was necessary to develop guidelines for determining whether funds are to be use for internal accounting purposes only, or reported as separate funds in the CAFR. The use of funds policy outlines the following reporting guidelines:

* All funds are considered internal funds. All internal funds are either external funds or combined external funds. External funds are reported as separate funds within the CAFR. Combined external funds are comprised of one or more similar funds for the purpose of external financial reporting.

* "Similar" funds are non-major funds of the same fund type that have the same function or are part of the same program, and are otherwise similar in nature.

* While the general fund is considered an external fund, non-major similar funds may be combined with the general fund if they are not required by law to be reported separately.

* Internal interfund activity must be eliminated when similar funds are combined for the purpose of external financial reporting.

Periodic Review. Again in deference to the number of funds principle, the city included in its policy a requirement to periodically review all funds to determine whether they should continue to be reported separately as external funds. If not, these funds are to be appropriately combined with another similar fund or with the general fund. The policy also stipulates that the city's fund structure is to be evaluated and updated in accordance with GFOA recommended practices and with generally accepted accounting principles.


State and local governments will continue to organize and operate their accounting systems on a fund basis for the foreseeable future. But as GFOA's 2004 recommended practice on fund accounting makes clear, there is plenty of room for improving government fund structures. Internal funds are a useful mechanism for demonstrating compliance with legal and administrative requirements, but including all of these funds in external financial reports makes such reports unnecessarily complex and difficult to understand for most users. By developing policies on the use of funds, governments like Westlake can manage internal and external funds in a way that meets the needs of all stakeholders.


(1.) National Council on Governmental Accounting Statement 1, Governmental Accounting and Financial Reporting Principles, paragraph 2.

(2.) Stephen Gauthier, Governmental Accounting, Auditing, and Financial Reporting (Chicago: GFOA, 20051): 17.

ANNE A. FRITZ, CPFO, is finance director of the City of Westlake, Ohio, and a member of GFOA's Committee on Accounting, Auditing, and Financial Reporting.
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Title Annotation:Best Practices
Author:Fritz, Anne A.
Publication:Government Finance Review
Geographic Code:1USA
Date:Jun 1, 2005
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