Chapter 1: Overview of Government and Not For Profit Accounting

1.1. Introduction

There are organizations whose object is not to make profit. These not-for-profit
organizations account their resources and financial activities under different accounting
system. Every organization wants to be successful. Of course, in order to know if it is
successful, “success” must be defined in terms of goals. And then it needs some means to
measure its results against its goals. Measuring success is often thought of in terms of
effectiveness (achieving the goal at the highest level) and efficiency (achieving the goal
through using the least amount of resources. for profit seeking organizations or
organizations whose objective is to make profit, both efficiency and effectiveness can
easily be measured with financial statement. There are certainly non financial criteria to
judge success like qualitative or quantitative measures. But regardless of what other
measures are employed, ultimately effectiveness will be measured by the income
statement. Not only income statement measures effectiveness, it also measures efficiency.
As with efficiency, there may be non-financial criteria for evaluating efficiency. But
ultimately, efficiency is evaluated by the expense section of the income statement. If
expenses are less than revenue and the organization has earned an “acceptable” profit, then
we can say it is successful in efficiency. We can therefore say that the objective of the
income statement is to demonstrate both the effectiveness and efficiency of the
organization.

For not-for-profit organizations (N-F-P) however, these objectives are not as useful.
Without a good measure of effectiveness, measurement of efficiency becomes almost
meaningless. If N-F-P accounting system cannot measure effectiveness (as can profit
seeking accounting systems), what then is their use? They are most often employed to
control public resources i.e. each person given custody of or access to public resources
should report back as to how they were used. The public can then hold the person
accountable for the proper use of the resources. This means that the income statement is
only limited to use in judging effectiveness. Both the nature of non profit organizations
and the objectives of their financial reporting have given rise to a particular accounting
method, i.e. the use of “fund accounting”
1.2 MEANING AND DEFINITION

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It is very important to understand the meaning of fund in this context. in normal
conversation “fund” means simply, a resource of money. That is not the meaning “fund”
has in Fund Accounting. In fund accounting, “fund” means a distinct entity within a
larger entity. A separate journal entry ledger will be kept and separate financial
statements will be kept for each fund. The fund accounting concept can be used to define
very clearly the purposes for which the resources are to be used, and who is to be held
accountable for the resources.
1.3 CLASSIFICATION OF NOT-FOR-PROFIT ORGANIZATIONS

Generally, organizations could be classified either based on their objectives or their

ownership. if Organizations are classified by their:
1. Objectives
a. Commercial / for profit organizations-
organizations- which emphasize on the making of profit
b. Non commercial/ not –for – profit organizations-
organizations- which do not give emphasis
on the making of profit
2. Ownership
a. Non-governmental (Private organizations) – are operating for the benefit of an
individual proprietor or, as partners, a group of partners or shareholders.
b. Governmental organization – are operated for the benefit of society as a Whole.
A non profit (not- for profit) organization is a legal accounting entity that is operated for
the benefit of society as a whole rather than for the benefit of an individual proprietor or a
group of partners or shareholders. Thus, the concept of net income is not meaningful for
non-profit organization. A non-profit organization strives only to obtain revenue & support
sufficient to coves its expenses.

Non-profit organizations comprise a significant segment of the country’s economy.

Basically, the following are suggested way of classifying NFP organizations.

1. GOVERNMENTAL UNITS
When thinking of governmental units, one tends to focus upon the federal government, or
on the states within the federal government (state governments) or those major local
governmental units or organizations within those governments. The federal government of
Ethiopia is comprised of states & Local governmental units.

E.g.- Regions of the federal government of Ethiopia are:

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 Tigray South nations & nationalities
Afar Gambella
Amhara Harari
Oroma Addis Ababa
Somalia
Benishangul /Gumuz

- Local governmental units are

1. Zone (Counties) – administrative division of the largest unit of local
government
2. Kifleketema
3. Kebele

2. EDUCATIONAL INSTITUTIONS
These could be private, public or community
E.g. Colleges & University, schools.

3. HEALTH CARE PROVIDERS

-Theses could be private , public on community
e.g. Hospitals, clinics, nursing home, red Cross

4. VOLUNTARY HEALTH & WELFARE ORGANIZATIONS (VHWO)

E.g. NGOS like USAID, Save the children, Care Ethiopia etc.

5. OTHER N.F.P ORGANIZATIONS

These are organizations whose objectives and activities are different from the above four
classifications.
E.g. Philanthropic foundations
Political parties
Civic organizations
Research & scientific organization
Professional association
In the above classification, governmental units are being categorized as N.F.P
organizations. However governmental units may undertake two types of activities.
- Profit making activates &
- Non-profit making activates

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The governmental units which undertake non-profit activates & the other indicated four
not-for-profit organizations are collectively known as Non-business
Non-business organizations.
organizations. It is
those organizations that we discuss in this course that use fund accounting system.

Students beginning the study of fund accounting temporarily must set aside many of the
familiar accounting principles for business enterprises. Such fundamental concept of
accounting theory for business enterprises as the nature of the accounting entity, the
primacy of the income statement and the pervasiveness of the accrual basis of accounting
have limited relevance in accounting for governmental units.

Thus the two types of non-business organization i.e. governmental units & the other NFPs
(how, health care, educational, other) have several characteristics in common as well as
differentiating features.

1.4 DISTINGUSH CHARACTERISTICS OF GOVERNMENTAL UNITS & NON-

PROFIT ENTITIES

For all the similarities and differences in the mechanics of accounting and management of
resources, there are very significant resources in what the two types of organizations do
and how they operate. First consider the three distinctions noted by the financial
accounting standards board (FASB) which characterize NFP organizations as
- receipts of significant amount of resources from resource providers who do not
expect to receive either repayment of economic benefit proportionate to the
resources provided
- operating purposes that are other than provide goods or services at a profit or profit
equivalent
- Absence of defined ownership interests that can be sold , transferred, redeemed, or that
convey entitlement to a share of residual distribution of resources in the event of
liquidation of the organization.

Putting this points in simple terms we might say that an NFP:

- gets money from people whom do not necessarily expect anything in return.(eg. Tax
payers, donors to NGOs)
- is not trying to make money
- does not have ownership shares that can be sold or bought

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From the standpoint of the management of resources, for profit and not for profit
organizations are similar different ways. For example both use the same type of resources
as cash, fixed asset personnel, etc... Since both are using the same type of resources, both
need good information for decision making, and both need to exercise careful control of
the resources that they have. This means that mechanics of providing information and
control system are similar for each. Both should imply accounting forms and other types
of controls to restrict the use of assets and capture information, double entry accounting to
record and classify that information, employing journals and ledgers, and then use those
journals and ledgers as a basis to produce periodic financial reports which summarise the
information in a meaningful way to guide decisions.

Despite the wide range in size and scope of governance, similarity & differences as the
accounting treatment as compared to business organizations, Governmental units and other
non-profit organizations would have the following common characteristics.

1. Organization to serve the society (citizens)

The basic principle of governmental philosophy is that governmental units exist to serve
the citizens subject to their jurisdictions. Thus the citizens as a whole establish
governmental units through the constitutional & charter process. In contrast, business
enterprises are created by only a limited number of individuals.

2. General absence of profit motive

With few exceptions, governmental units render services to the citizenry with out the
objective of profiting from those services. Business enterprises are motivated to earn
profit.
3. Society as a principal source of revenue
As with governmental units, most non- profit organization depend on the general
population for a substantial portion of their support. Because revenue from charges for
their services is not intended to cover all their operating cost Exceptions are
professional societies and the philanthropic foundations established by wealthy individuals
or families, whereas the citizenry contributions are mostly involuntary Taxes. Citizen’s
contribution to non-profit organizations is voluntary donations. There is no comparable
source for business enterprise.

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N.B it is important to know about types of taxes for the future topics. Tax is an
involuntary contribution from the society to the government. based upon their assessment,
taxes could be classified into -

i) Self assessed taxes: - taxes, which are assessed and declared by the tax payer
e.g. Income tax, value added tax
ii) Government assessed taxes:
taxes: - taxes determined and levied by the governmental
authorities.
E.g. property tax, customs duty, Excise Tax

4. Importance of budget
Governmental accounting systems as we have seen are employed by government
resources. That is each person given custody of or access to resources should report back
as to how they were used. The government can then hold the person accountable for the
resources. This means that budget become highly important in governmental entities.
Since expenditures are divorced from revenue collections, the use of governmental
resources is compared to the budget. The four-proceeding characteristics of non – profit
organizations also cause their annual budget to be as important as for governmental units.
Non- profit organizations may employ object budget, programming budget or performance
budget.

5. Stewardship for resources

A primary responsibility of governmental units in financial reporting is to demonstrate
adequate stewardship for resources provided by its citizenry. Non-profit organizations
have a comparable responsibility to their donors but not to the same extent as
governmental units.

1.5 USES AND USERS OF FINANCIAL REPORTS OF GOVERNMENTAL UNITS

Since financial reports are means of communicating the operation results & position, it is
required for both business & non-business organizations. Financial reports could either be
for a year (annual financial reports) or for a period less than a year (interim financial
report). Every states and local governmental units are required to prepare annual financial
reports, which would render information about the operation results & position to users.
The users are categorized into as:

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 i). Internal – who are the governing body of the states & local governmental
ii). External - who are the society /citizenry.

The governmental accounting standards board (GASB), which is one of the responsible
body in developing accounting & reporting standards for state & local governmental units
in its concepts statement no.1 “objectives of financial reporting”, it established the
following objectives.

GASB Reporting Objectives

I. Financial reporting should assist in fulfilling governmental duty to be publicly
accountable & should enable users to assess that accountability by:
a) Providing information’s to determine whether current year revenues were
sufficient to pay for current year services.
b) Demonstrating whether resources were obtained & used in accordance with the
entities legally adopted budget & demonstrating compliance with other finance
related or contractual requirements.
c) Providing information to assist users in assessing the service efforts, costs &
accomplishment of the governmental entity.

II. Financial reporting should assist users in evaluating the operating results of the
governmental entity the year by:
a) Providing information about sources and uses of financial resources.
b) Providing information how it financed its activities and met its cash
requirements.
c) Providing information necessary to determine whether its financial position
improved or deteriorated as a result of the year’s operations.
III. Financial reporting should assist users in assessing the level of services that can be
provided by the governmental entity and its ability to meet its obligations as it become
due by.
a) Providing information about its financial position and condition
b) Providing information about its and other non-financial resources.
c) Disclosing legal or contractual restrictions on resources and the risk of
potential loss of resources.

It can be understood from the statement that Accountability is the cornerstone of all
financial reporting in government. Accountability requires governments to answer to

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 the citizens, to justify the raising of public resources and the purposes for which they
are used. Governmental accountability is based on the belief that citizenry has a “right
to know” a right to receive openly declared facts that may lead to public debate by the
citizens and their elected representatives. Financial reporting plays a major role in
fulfilling government’s duty to be publicly accountable in a democratic society. the
GASB believe that inter period equity is a significant part of accountability and is
fundamental to public administration. It therefore needs to be considered when
establishing financial reporting objectives. In short financial reporting should help users
assess whether current year revenues are sufficient to pay for services provided that
year and whether future taxpayers will be required to assume burdens for services
previously provided.

Financial reports of Non profit organizations- Voluntary health and welfare organizations,
college and universities, Hospitals, religious organizations and others- have similar uses
but, in recognition of the fact that the financial operations of NFPs are generally not
subject to as detailed legal restrictions as are those of governments,

The financial accounting standards board believes the financial reports for not-for-profit
organizations should provide
1. Information useful in making resource allocations decisions;
2. Information useful in assessing services and ability to provide services;
3. Information useful in assessing management stewardship and performance; and
4. Information about economic resources, obligations, net resources and changes in
them.

Note the objectives of financial reporting for governments and for non-profit entities stress
the need for public to understand and evaluate the financial activities and management of
these organizations.

Government Financial Reporting

Serious users of government financial information have the need for much more detail
than what is found in the audited general-purpose financial statement (GPFS). Much of
that detail as well as the auditors report and the GPFS are found in the governmental
reporting entity’s Comprehensive Annual Financial Report (CAFR) which is considered as
the entity’s official Annual report published as a matter of public record.

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1.6 SIMILARITIES AND DIFFERENCES BETWEEN GOVERNMENTAL AND
COMMERCIAL ENTITIES

Similarities
1. Impact of legislative process
The federal, state & local laws & regulations would have an impact upon both
Governmental & commercial entities. However the level of legislative impact is not as
strong for commercial units as it is for governmental entities.

2. Stewardship for Resources

Since the resources of commercial entities are provided by the owners themselves, they
are taking full responsibility or the accountant along with the owner will be taking the
responsibilities for the stewardship of resources. In the same way, members of the
governmental entities should demonstrate adequate stewardship for resources.
3. Importance of Budget
The overall nature of governmental & commercial entities require a plan of expected
expenditure and income to be implemented for both entities. it is important to employ
relative budgets as per their accounting entities.

Differences
1. Profit motive
Commercial units have a presented profit motive as part of their objectives where as
governmental units with some exceptions does not operate with the objective of earning a
profit.

2. Governance
The legislative and executive branches of a governmental unit share the responsibilities for
their governance where as in the case of commercial entities; it is governed by elected or
appointed directors or managers.

3. Basis of accounting
The modified accrual basis of accounting is mostly used by some governmental units but
in case of commercial entities the basis of accounting is the accrual basis.

4. Source of revenue in nature

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The primary source of revenue for commercial entitles is through sales or services they
provide, whereas in case of governmental units, with some exceptions, the main source of
revenue is though fund or donations.

5. Beneficiaries
Governmental units are operating for the benefit of the citizenry where as commercial
entities are operating for the interest and benefit of the owners.

1.7 SOURCE OF ACCOUNTING STANDARDS

Accounting and financial reporting standards for state and local governmental units are
established by the governmental accounting standards board (GASB).

Accounting and financial reporting standards for profit seeking business are established by
the financial accounting standards board (FASB)
(FASB)

The GASB and the FASB are parallel bodies under the oversight of the Financial
Accounting Foundation. they are referred to as “ independent standard setting boards” in
the private sector. Before the creation of the GASB & FASB, financial reporting standards
were set by groups sponsored by professional organizations. Before 1934 in US, there was
no governmental accounting standard. But by 1934, to overcome this confusion & scandal
specially in municipality accounting, the Municipal Finance Officers Association (MFOA)
formed, the National Committee on Municipality Accounting (NCMA)
(NCMA) to assure
accounting standard for municipalities. By expanding its scope, the NCMA in 1949 was
reorganized as National Committee on Governmental Accounting (NCGA) to establish
accounting standards for states and local governmental units. In 1974, the committee was
again reorganized as a council and formed the National Council of Governmental
Accounting (NCGA). In 1984 the council was again reorganized as a board parallel to
FASB and was renamed as Governmental Accounting Standards Board (GASB).
(GASB).

Authority to establish accounting principles (financial reporting standards for non profit
organizations) is split between the GASB and the FASB. Because a sizable number of
none profit organizations (particularly colleges, universities & hospitals) are
governmentally related. But many others are independent of governmental units.
Accordingly the GASB has the responsibility for establishing accounting & financial
reporting standards for not for profit organizations whose financial statements may be

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combined with the financial statements of state and local governmental reporting entities,
or which are considered governmentally owned.

The FASB has the responsibility for establishing accounting and financial reporting
standards for non-governmental non-for profit organizations. Both the GASB and the
FASB have issued concept statements, which are intended to communicate the framework
within which the two bodies strive to establish consistent financial reporting standards for
entities within their respective jurisdictions.

The financial accounting foundations appoints the members of the two boards & supports
the operating expenses of the boards by obtaining contributions from business
corporations, professional organization of accountants, financial analysts, CPA firms and
other groups concerned with financial reporting.

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