Fund Balance - Understanding CAFRs

Every year a city has to produce a financial report known as a CAFR (pronounced "calf-er").  This is how a local or state government accounts for how it spent its money from the previous fiscal year.

To get an overview of what a CAFR is, click here.  

As you can imagine lots of people are anxious to read it when it comes out.  Okay, well maybe not lots, but some are.  

One of the reports that is analyzed is known as the fund balance.  

Too bad it's not called the "Fun Balance" or it might look something like this:
But it actually looks more like this:  

This balance sheet is sorely lacking in fun. 

According to GASB, the Governmental Accounting Standards Board that oversees city and state finances, the simple explanation of a fund balance is the difference between assets and liabilities in a governmental fund.  This means how much we have and how much we owe.  Sounds easy enough, right?  


Over 11 years ago, GASB conducted a survey and found that only three out of ten respondents were able to correctly interpret the fund balance.

As members of that 70%, let's try to figure out why.

The main reason is that when you look at a fund balance, you aren't seeing the whole story.  It's not just a matter of positive or negative.

Funds fall in different categories:  

Nonspendable fund balance

These amounts are not spendable because they are either inventory or required to be maintained in tact (like an endowment fund). 

Restricted fund balance

These amounts are constrained to a specific purpose by their providers, through the constitution, or by enabling legislation, like an initiative.  In other words, the city itself doesn't get to decide where the money goes.  California's state's funds are 85-90% restricted thanks to initiatives.

To read more about how initiatives work and the impact they have, click here.  

Committed fund balance

These amounts are constrained by government itself using its highest level of authority.  It can't change purposes unless the same highest level of authority removes or changes the constraint.  

Assigned fund balance

These amounts are what a government intends to use the money for.  Determining the purpose can be done by an official or delegated authority.  

Unassigned fund balance

These amounts are available for any purpose and are found in the general fund.  

According to GASB, where many make the mistake is they fail to interpret the fund balance within its particular fund and instead from the perspective of all funds.

Here are some of the different kinds of funds a city may have.  
·       The general fund, where a government accounts for everything not reported in another fund
·       Special revenue funds, for reporting specific revenue sources that are limited to being used for a particular purpose
·       Debt service funds, which account for the repayment of debt
·       Capital project funds, which track the accumulation and use of resources for constructing, acquiring, and rehabilitating capital assets, such as buildings and roads
·       Permanent funds, where a government reports principal amounts that are restricted to being invested to produce income but cannot be spent.

Think of them as different buckets.  Each will have a different amount inside.  
As you can imagine the following scenario would be tempting.

Bucket B looks over at Bucket A and says, "Hey you've got lots of water in your bucket, and I'm running out.  Can you give me some of your water?"  

Bucket A says, "Sorry, my water is RESTRICTED, and I can't pour any of it into your bucket."  

Bucket B says, "The system stinks!" and stomps off.  

But does the system stink?  If you want to see the government run like a business then you probably think it does.  After all, if a business needed more money for R&D, it could cut back on its marketing budget to help develop the product.  Once the product is developed, it can then put more money into the marketing bucket.  
But governments can't run like a business.  Governments operate under multiple constraints, whereas businesses operate to be profitable.

To read more about why a government can't run like a business, click here.  

Going back to our buckets, let's look at another scenario.

Bucket B looks over at Bucket A and says, "Hey you've got lots of water in your bucket, and I'm running out.  Can you give me some of your water?"

Bucket A says "I have water I can give you but I have to ask the City Council first."

City Council says, "Yes, go head and pour some of your water into Bucket B."  

Bucket A pours some of its committed funds into Bucket B.  This is known as a transfer of funds. 
Bucket A gave some water to Bucket B
But then later Bucket A's water gets too low and wants some of it's money back.  
Bucket A has less water than Bucket B

Bucket A says "Dude, I need some of my water back."
Bucket B says, "Let me go ask the City Council."
Bucket B comes back.  "Sorry, they said no."
Bucket A says, "The system stinks!"

Note: Transferring funds is not as simple as I'm making it seem.  To better understand why this issue is complicated, visit the Utah League of Cities and Towns website.   But the moral of the story is, don't mess with the buckets unless you know what you are doing and have considered future ramifications.  

GASB provides this advice and warning:  

"...[I]t is advisable to use fund balance information with some caution. To begin with, you need to understand the purpose of the funds a government reports."

If your city has candidates running for city council or mayor and they claim that they can "fix the budget" or "know how to increase services without increasing taxes."  Beware.  They might be reading the CAFR incorrectly.  Consider asking them these questions:  
  • What is your understanding of fund balance?
Just because someone can read a balance sheet, doesn't mean they can understand fund balances.
  • Have you discussed your ideas with the city's finance director to determine if your plan will work?  
Government accounting is different than business accounting. Talk to the professionals.
  • Do you understand the difference between the General Fund, Special Revenue Funds, and Capital Projects?
Transferring water from one bucket to another might be easy, but not when it comes to transferring government funds, it can have major deleterious consequences.

And most importantly, 

  • Can you do this? 

To read more about what government accountants do and who they answer to, click here.  

Note:  Two GASB sources were used for this article.  One titled "The User Perspective" published in May 2006 reveals the results of the survey and refers to Statement No. 38, Certain Financial Statement Note Disclosures.  In February 2009, that statement was superseded by Statement No. 54 Fund Balance Reporting and Governmental Fund Type Definitions which is what I used to delineate the different fund balance categories.