2 The Basic Financial Statements


Financial statements help managers answer a variety of questions:

  • What and how much does the organization own? What and how much does it owe? Does this organization have enough financial resources to cover its obligations as they come due?
  • What are the major sources of revenue for this organization? What are its spending priorities? Do the organization’s sources of revenue and spending priorities reflect the organization’s core mission?
  • How much of this organization’s spending does it control? How much of its spending is directed by outside stakeholders like donors, clients, residents, or investors?
  • How much, if any, does this organization report in “reserves” or its “rainy day fund”? Given its operations, what would be the optimal level of reserves?

In November 2013, the Contra Costa County (California) Board of Supervisors voted to end nearly $2 million in contracts with the non-profit Mental Health Consumer Concerns (MHCC). The reason: MHCC’s savings account had grown too large.

Since the late 1970s, MHCC has offered patient rights advocacy, life skills coaching, anger management classes, and several other mental health-related services to its poorest residents of the Bay Area. Much of its work was funded through contracts with local governments.

In 2007, its Board of Trustees began to divert 10-15 percent of all money received on every government contract to a reserve account (or rainy-day fund). MHCC’s management concluded that this policy was necessary after several governments were consistently late on their payments. MHCC’s plan was designed to guarantee that the organization would not be exposed to unpredictable cash inflows. The board and management considered this a prudent use of public dollars and a necessary step to protect the organization’s financial future. Beginning in 2007 through 2011, nearly $400,000 flowed into the new rainy-day fund.

Contra Costa County disagreed. They interpreted the contracts to mean reimbursements were only for actual service delivery expenses. They also pointed out that those contracts prohibited carrying over funds from year to year. A reserve fund containing County funds was, therefore, a violation of those contracts. MHCC pointed out that they disclosed the reserve fund strategy in their annual financial reports. The reserve allowed them to deliver services uninterrupted, even during the worst moments of the Great Recession. Contra Costa County Supervisor Karen Mitchoff responded by saying MHCC’s financial statements were not the appropriate channel to communicate such a contentious policy choice. She added, “I am not sympathetic to the establishment of the reserve, and the non-profit board knows they had a fiduciary responsibility to be on top of this.”

The contracts were canceled, and MHCC dissolved in early 2011.

This episode illustrates two of the key takeaways from this chapter. First, an organization’s financial statements are a vital communication tool. They tell us about its mission, priorities, and service delivery strategy. In this case, MHCC made a policy decision to deliver less service in the near term in exchange for the ability to deliver more consistent and predictable services in the future. That choice is reflected in MHCC’s financial statements (e.g., assets exceed liabilities, and unrestricted net assets were a significant proportion of net assets). MHCC disclosed the rainy-day fund policy in the notes to its financial statements. Second, and more importantly, financial statements are only useful if the audience knows how to read them. In this case, Contra Costa County failed to understand how the rainy-day fund policy was communicated in the financial statements and how it affected MHCC’s finances and its ability to accomplish its mission. Without the ability or desire to interpret the financial statements, the County considered MHCC’s actions a breach of contract. Whether a rainy-day fund is, a direct service expense is an important policy question. So is the question of if and how a government should use financial statements for oversight of its non-profit contractors. But to engage these and many other questions, one must first understand how a public organization’s financial statements tell its “financial story.”


After reading this chapter, you should be able to:

  • Identify the fundamental equation of accounting.
  • Identify the basic financial statements: balance sheet, income statement, and cash flow statements.
  • Recognize key elements in every financial statement, including assets, liabilities, revenues, expenses, change in net assets, change in net position, and change in fund balance.
  • Understand what information each statement is designed to convey about an organization.


If you want to know how an organization connects its money to its mission, read its budget. If the budget calls for more spending in one program and less in another, that tells us a lot about that organization’s priorities. If one of its programs operates at a loss – but another program’s profits subsidize that loss – that is also a clear statement about how that organization carries out its mission. We can think of many other ways an organization’s money does or does not connect to its mission. A public organization’s budget lays out the many unique ways it makes those connections.

But sometimes, we want an “apples-to-apples” comparison. Sometimes we want to know to what extent an organization’s mission-money nexus is the same or different from similar organizations. Sometimes we want to know how efficiently an organization accomplishes its mission compared to its peers. Sometimes we want to know if an organization is in comparatively good or bad financial health. To answer these types of questions, you need information found only in financial statements. In this chapter, we walk through the basic financial statements and the essential concepts from accounting you need to understand in order to interpret the information presented in those statements.

We may need to compare an organization’s finances to the finances of other organizations. If our organization’s expenses exceeded revenues, we might consider that to be a failure – unless, of course, we see organizations like it face similar challenges. If it failed to invest in its capital equipment, we might think it was neglecting its service delivery capacity – unless we saw other organizations make that same trade-off. These comparisons demand financial information based on standardized financial information from a broadly shared set of assumptions. As you’ll see in Chapters 5 and 6, budgets rarely present information in a standard format.

Fortunately, we can get that information from an organization’s financial statements. Financial statements are the main “output” or “deliverable” from the organization’s accounting function. Accounting is the process of recording, classifying, and summarizing economic events in a process that leads to the preparation of financial statements. Unlike budgets, the numbers reported in financial statements are based on generally accepted accounting principles (GAAP) that prescribe when and how an organization should acknowledge economic activity.

GAAP tells us when an organization can say it owns an asset or earned revenue for delivering a service. These are known as principles of accounting recognition. The key point is that GAAP is a shared set of “rules of the game” for summarizing and reporting an organization’s financial activities. If an organization offers GAAP-compliant financial information, we can compare its finances to itself over time and to other organizations.

Standardized rules are not the only difference between budgeting and accounting. Broadly speaking, if budgeting is the story, then accounting is the scorecard. An organization’s budget tells us the activities it wants to do, how it plans to pay for those activities, and what it hopes to achieve. Politicians and non-profit board members love to talk about budgets because budgets are full of aspirations. Budgets are how leaders translate their dreams for the organization into a compelling story about what might happen.

Financial statements tell us what happened. Did the organization’s revenues exceed its expenses? Did it pay for goods and services it received with cash or on credit? Did its investments gain value or lose value? How much revenue would it need to pay for capital improvements and equipment? Accountants often see themselves as the enforcers of accountability. That is why budget-makers and accountants often don’t see eye-to-eye.

These two worldviews are different in many other important ways. As mentioned, budgeting is prospective (i.e., about the future), whereas accounting is retrospective (i.e., focused on the past). Budgets are designed primarily for an internal audience – elected officials, board members, department heads, program managers, etc. In contrast, accounting procedures produce financial reports mostly for an external audience, including taxpayers, investors, regulators, and funders. Budgeting focuses on resources that flow in and out of an organization, also known as the financial resources focus. Accounting focuses on the long-term resources the organization controls and its long-term spending commitments, also known as the economic resources focus. In preparing a budget, the focus is on revenues and spending. In accounting, the focus is on assets and any claims against those assets. We present a summary of these perspectives in the table below.

Metaphor “The Story” “The Scorecard”
Viewpoint Prospective Retrospective
Format Idiosyncratic / Customized Standardized
Audience Internal External
Focus of Analysis Inputs / Outcomes Solvency/Financial Health
Organizing Equation Planned Revenues = Planned Spending Assets = Liabilities + Net Assets
Measurement Focus Financial Resources Economic Resources
Cost Measurement Market Price Historical Cost



The Financial Accounting Standards Board (FASB) produces GAAP for publicly traded companies and non-profits. The Governmental Accounting Standards Board (GASB) produces GAAP for state and local governments. Both the FASB and the GASB are governed by the Financial Accounting Federation (FAF), a non-profit organization headquartered in Norwalk, CT, just outside of New York City. Both Boards are comprised of experts from their respective groups of stakeholders: accounting, auditing, “preparers” (entities that prepare financial statements, like companies and governments), and academia. The Securities and Exchange Commission (SEC), the federal government agency that regulates public companies, designates the FASB as the official source of GAAP for public companies. The GASB has not been designated as such. Still, it is the de facto source of GAAP for governments because key stakeholders like municipal bondholders and credit ratings agencies have endorsed its standards. GAAP for federal government entities is produced by the Federal Accounting Standards Advisory Board (FASAB). The FASAB is comprised of accountants and auditors from federal government agencies. Federal government GAAP is still an emerging set of concepts and practices.


Everything we do in accounting is organized around the fundamental accounting equation. That equation is

Assets = Liabilities + Net Assets

An asset is anything of value that the organization owns. There are two types of assets: 1) short-term assets, known more generally as current assets, and 2) long-term or non-current assets. A current asset is any asset that the organization will likely sell, use, or convert to cash within a year.

When someone outside the organization owes money, and the organization expects to collect that money within the year, that obligation is known as a receivable. If it’s due within the year, it is classified as a current asset. An organization recognizes an account receivable or A/R when it delivers a service to a client and that client or customer agrees to pay within the current fiscal year. Non-profits frequently report donations receivable or pledges receivable. Pledges receivable represent a donor’s commitment to give at a future date. The same logic applies to grants receivable when foundations or governments commit to giving the organization a grant. Governments recognize an overdue tax payment as taxes receivableDue from other governmental units represents payments due to a government from other governmental units.

Organizations will report inventory or supplies if they expect to use these resources as they carry out routine operations. These are also current assets.

Most public organizations own buildings, vehicles, equipment, and other assets they use to deliver their services. These are long-term assets, as the organization expects to use them over multiple years (frequently referred to as useful life). Organizations are not likely to sell these assets, as doing so would diminish their capacity to deliver services. State and local governments build and maintain roads, bridges, sewer systems, and other infrastructure assets. These are among the most expensive and essential long-term assets in the public sector.

By contrast, a liability is anything the organization owes to others. To put it in more favorable terms, liabilities are how an organization acquires its assets. Here the short-term (or current) vs. long-term distinction also applies. Current liabilities are liabilities that the organization expects to pay within the next fiscal year. The most common are accounts payable for goods or services the organization has received but not yet paid for and wages payable for services delivered by employees but not yet paid for.

Long-term liabilities are money the organization will pay at some point beyond the current fiscal year. When an organization borrows money and agrees to pay it back over several years, it recognizes a loan payable or bonds payable. Many public sector employees earn a pension while they work for the government, and they expect to collect that pension once they retire. If the government has not set aside enough money to cover those future pension payments, it must report a pension liability (sometimes referenced as net pension liability).

What’s left is called net assets. Technically speaking, net assets represent the difference between assets and liabilities. For private sector entities, this difference is known as the owner’s equity. Public organizations do not have “owners.” Instead, they have stakeholders, or anyone interested, financial or otherwise, in how well the organization achieves its mission. For governments, taxpayers are a rough analog to owners. But unlike shareholders, taxpayers do not have a legal claim to the government’s assets. Their priorities also differ. Taxpayers want to see their governments deliver the services.

Similarly, donors expect contributions to be used to provide services. They do not expect to get their money back if the organization fails. However, they care about the organization’s financial position and frequently focus on whether its operations are sustainable and will continue serving the public for generations to come. For these reasons, net assets are an important part of government and non-profit finances, but they do not have quite the same meaning as owners’ equity for a for-profit entity.

That said, irrespective of sector, we should think of net assets as an indicator of the organization’s financial strength. If its net assets are growing, that suggests its assets are growing faster than its liabilities, and in turn, so is its capacity to deliver services. If its net assets are shrinking, its service-delivery capacity is also shrinking.

We also have to think about the restrictions on net assets. The new accounting rules require non-profits to report net assets “without donor restrictions” and net assets “with donor restrictions.” Prior to FASB Accounting Standards Update 2016-14, net assets reported as unrestricted are now reported as net assets without donor restrictions. Net assets reported as temporarily restricted (i.e., net assets with time or use restrictions) or permanently restricted (i.e., net assets with restrictions that do not expire) are now reported as net assets with donor restrictions. While ASU 2016-14 is a significant change in how non-profits present financial information in their audited financial statements, how they account for these resources in day-to-day operations remains unchanged. Put differently, changes in GAAP do not alter or amend donor intent. Non-profits will need to continue to track gifts – but report in the financial statements in aggregated categories.

Governments use separate classification schemes, but these are a bit more detailed. We describe that scheme later in this chapter. 


In for-profit organizations, the fundamental equation is Assets = Liabilities + Owners’ Equity. Conceptually, every shareholder has a claim to assets that do not have an offsetting liability. Put differently, shareholders have a claim to all assets not otherwise promised to creditors or suppliers. When you buy a for-profit company’s stock (or “shares”), you are, in effect, purchasing a portion of that company’s owner’s equity. That’s why stocks are also known as equities. If a company’s assets grow faster than its liabilities, its equity will become more valuable, and the price of its stock will increase, meaning investors who hold that stock make money. If, for example, you had invested in Apple stocks before the first iPod came to market in 2001, as of June 30, 2023, your portfolio’s value would have increased by 58,679 percent (from $0.33 per share to $193.97 per share). The price of Apple shares reflects growth in revenues and, correspondingly, growth in assets.


Organizations that follow GAAP produce three basic financial statements:

  1.   A Balance Sheet summarizes the organization’s assets, liabilities, and net assets at the end of the fiscal period (e.g., as of December 31, 20XX).
  2.   An Income Statement presents a summary of the organization’s revenues, expenses, and changes in net assets for the fiscal year (e.g., for the year ending December 31, 20XX).
  3.   A Cash Flow Statement shows how the organization receives and uses cash to carry out its mission (e.g., for the year ending December 31, 20XX).

In the discussion that follows, you will see more detail about each statement and how the information it contains can inform key management and policy decisions.

When considering an organization’s financial statements, keep one central point in mind: Net assets are the focal point. Regardless of the organization’s structure or mission or changes in assets, liabilities, revenues, expenses, and cash flows will affect net assets. While the content of each financial statement differs, the focus is on net assets.

Additionally, each statement’s presentation style and terminology vary depending on the sector. The table below summarizes these differences.


Government-Wide Statements

Governmental Fund Financial Statements

Proprietary Fund Financial Statement

Balance Sheet Balance Sheet or Statement of Financial Position Statement of Financial Positions Statement of Net Position Balance Sheet Statement of  Net Position
Income Statement Income Statement, Profit & Loss (P&L) Statement, or Operating Statement Statement of Activities Statement of Activities Statement of Revenues, Expenditures, and Changes in Fund Balances Statement of Revenues, Expenses, and Changes in Net Position
Cash Flow Statement Cash Flow Statement or Statement of Cash Flows Statement of Cash Flows N/A N/A Statement of Cash Flows

Many of the labeling differences are intended to contrast the mission orientation of non-profits and governments with the profit orientation of for-profits. We see this most clearly in the income statement. For-profit organizations often refer to the income statement as the “profit/loss statement,” given that its purpose is to distinguish its profitable products and services from its non-profitable products and services. For governments and non-profits, the focus is on “activities.” The question here is not whether the organization’s activities are profitable but how those activities advance its mission. To be sustainable, every organization must generate more income than it incurs in expenses. That said, profitability is not a primary objective for public sector organizations, as it is in the private sector.

You will also note several differences in what governments call these statements. We have already discussed how financial statements illuminate operational accountability or how efficiently and effectively an organization uses financial resources to advance its mission. Taxpayers want to know that their government delivers services efficiently and effectively. To that end, state and local governments prepare “government-wide” financial statements. These statements present the government’s overall financial position. These statements offer some insights into the government’s ability to continue to deliver services in the future. With a few modifications, these government-wide statements are conceptually like the basic financial statements for a non-profit or for-profit.

The government-wide balance sheet is called the Statement of Net Position, and the government-wide income statement is called the Statement of Activities. By referring to the income statement as the Statement of Activities, standard setters have sent a clear message: governments exist not to generate income but to produce activities. This also explains why there is no government-wide cash flow statement. Information about how a government generates and uses cash does not necessarily help us understand if it is achieving its mission.

But with governments, operational accountability is only part of the story. Taxpayers also want to know if their government did what they told it to do. They want to know if services were delivered with revenues collected. That’s fiscal accountability.

When we think of fiscal accountability in government, we usually think of the budget. A government’s budget is not just a plan – it is the law. Most governments’ constitutions or charters require them to lay out their planned revenues and spending in a special law called an appropriations ordinance. They must pass legislation that makes their budget intentions clear. If they spend more than their budget allows or if monies are spent in ways not specified in their budget ordinance, they are breaking the law.

Budgets are enshrined in law because they are one of our most effective tools to ensure inter-period equity. Inter-period equity is the idea that if a government presents and approves a balanced budget, it is living within its means and not passing costs onto future generations.

Fiscal accountability and inter-period equity are so important that they are built not just into a government’s budget but also its financial statements. For instance, imagine a school district levies a property tax to pay for school buildings. Taxpayers want to see how much revenue that tax generated, how much money the school district borrowed for capital improvements, how much of that revenue is being used to repay those borrowed funds, and so on. They want fiscal accountability on that special tax. To assess this, taxpayers need to see those revenues, expenditures, assets, and liabilities presented separately from all other operations. To do that, the school district must present those finances in a stand-alone special revenue fund.

fund is a stand-alone, self-balancing set of accounts with a specific purpose. The General Fund has every government account for services paid for through general revenue sources. It is where local governments account for police, fire, public health, and other essential services paid for using locally adopted property and sales taxes. It is where state governments account for funding for education (K-12, public universities, and community colleges), public health, public safety, and other essential services paid for using state-wide income and sales tax revenues. For most governments, the General Fund is the largest and most carefully watched. According to GAAP, a government’s General Fund, special revenue funds, debt service fundscapital projects funds, and permanent funds are collectively called governmental funds. The governmental funds account for the government’s core operations and services.

Like budgets, governmental funds focus on near-term revenues and spending (also known as current financial measurement focus). For that reason, the information you see in governmental funds statements is prepared using a different set of accounting principles. Those principles are known as modified accrual accounting (or “fund accounting”). Modified accrual basis of accounting measures the current financial resources available. To that end, revenues are recognized when they are both measurable (i.e., revenues can reasonably be estimated) and available (i.e., revenues are available within 60 days). Expenditures are recognized when the costs have been incurred to acquire goods or services in the current period.

Funds are so important to governments that governments are required to present a separate set of fund financial statements prepared using the modified accrual basis of accounting. The balance sheet in the governmental funds is called the Balance Sheet, and the income statement is called the Statement of Revenues, Expenditures, and Changes in Fund Balance.

Governments also deliver goods and services whose operations are similar to what we would find in the private sector. Examples include water and electric utilities, golf courses, swimming pools, and waste disposal facilities, to name a few. These are known as business-type or proprietary activities. In concept, business-type activities should cover their expenses with the revenue they generate through charges for services. Many governments operate business-type activities because they are profitable and can subsidize other services that cannot pay for themselves. Since business-type activities pay for themselves, we account for them on an accrual basis and prepare a separate set of fund statements referred to as proprietary fund statements. Accrual basis of accounting reports on a transaction when it has an economic impact, regardless of whether it spends or receives cash. Governments reporting business-type activities will prepare a Statement of Net Position, Statement of Revenues, Expenses, and Changes in Net Position, and a Statement of Cash Flows in the proprietary fund statements.


You will find an audit report at the beginning of every set of financial statements. The report, formatted as a letter prepared by an external financial auditor, is presented to the organization’s board and management and incorporated in the audited financial statements. The auditor performs a series of tests to assess the strength of internal controls (i.e., rules and procedures adopted by an organization to prevent fraud and abuse) and reviews a representative sample of transactions. Their work is designed to answer a simple question: Are the organization’s financial statements a fair presentation of its actual financial position? Usually, the audit report expresses an unqualified opinion, meaning the auditor believes the financial statements are a fair presentation of the organization’s financial position, operations, and cash flows. An unqualified audit report will contain language to the effect of “…these financial statements present, fairly, and in all material respects, this organization’s financial position.” If the auditor has reason to believe the financial statements do not present that position fairly, they will issue a qualified opinion or, in rare cases, an adverse opinion or disclaimer of opinion.


The basic financial statements of non-profit organizations include the Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses. Below is a quick review of each statement.


The Statement of Financial Position, the non-profit’s balance sheet, is designed to answer a simple question: What is this organization’s financial position? Financial position has both short-term and long-term components. If current assets exceed current liabilities, then the organization’s short-term financial position is favorable. If long-term (i.e., non-current) assets exceed long-term liabilities, the organization is in a favorable long-term financial position. As you will see in the discussion that follows, an organization could be in a favorable long-term financial position but have a weak short-term financial position, and vice versa.

For that reason, a point of emphasis for the balance sheet is the relationship between the organization’s assets and liabilities. An organization’s net position improves if its assets grow faster than its liabilities. If an organization’s assets decrease or liabilities increase, its net position will deteriorate. We are always mindful of why an organization’s net position has declined over time. Is that because the organization drew down on its reserves during a recession, or do changes reflect a loss in value in the non-profit’s investments? The balance sheet offers a lot of this sort of detail. It also helps organizations formulate strategies to address the issues at hand. If the organization had to draw down on its reserves because of a deficit, it would need to budget for a surplus to replenish reserves. If the organization reported investment losses because of changes in the financial markets, it might opt to do nothing. Doing nothing is a strategy. We’ve seen the markets recover following a recession, including the Great Recession and the COVID-19 recession.

We provide a review of financial health measures, also known as financial statement ratios, that can help you answer some of these questions. Below are some questions you should ask when looking at an organization’s balance sheet:

  1. Do its total assets exceed its total liabilities? If they do, that is an indicator that the organization’s long-term financial position is favorable.
  2. Do its current assets exceed its current liabilities? If they do, that is an indicator that the organization’s strong short-term financial position, sometimes referred to as working capital, is favorable.
  3. Of total assets, what proportion are current assets? What proportion are fixed assets (i.e., buildings and equipment)? What proportion are restricted investments? Buildings and equipment add to operating costs (i.e., maintenance and operating costs). Investments, including restricted (or endowment) investments, are a real source of income, and unrestricted investments may be used to support the organization’s operations.
  4. Of current assets, what proportion are receivables? What proportion of receivables is due in 12 months or less? What proportion of receivables due is from a single donor or grantor? The concentration of receivables with an individual donor is a source of financial uncertainty.
  5. What proportion of assets is in the form of cash and cash equivalents? What proportion of current assets is in the form of cash and cash equivalents? How much cash does the organization have relative to its current liabilities? We often hear the phrase cash is king. Cash is a liquid asset that allows the organization to meet its obligations as they come due and provides it with the opportunity to invest in new opportunities or immediately respond to a crisis. At the same time, an organization can have too much cash. If it has more cash than it needs to cover its day-to-day operations, it could invest some of that idle cash in marketable securities or other safe investments and earn a nominal return.
  6. What proportion of net assets is without donor restrictions? What proportion of net assets is with donor restrictions? Net assets without donor restrictions can be used to cover short-term spending needs, while net assets with donor restrictions cannot, as doing so would violate donor intent.
  7. Does the organization have non-current liabilities? How might these affect the organization’s current assets in the future? Long-term liabilities like loans, bonds, legal settlements, and pension liabilities increase demand for cash.

It is essential to keep in mind that the balance sheet is a snapshot in time. When an organization’s accounting staff prepares the balance sheet, they present balances in every account on a particular day, usually the last day of the fiscal year. If an organization has a dynamic balance sheet, its financial position could look quite different from one week to the next or one month to the next based on activities in key balance sheet accounts (e.g., cash, accounts receivable, and investments).

Let’s look at an example. The Statement of Financial Position for Treehouse for the year ending June 30, 2022, is below. The financial statements include consolidated accounts of Treehouse and 2100 LLC (i.e., Treehouse’s interest in the 2100 Building) in FY 2022. Treehouse did not include FY 2021 information in its financial statements at the end of FY 2022. That information is presented here for comparison purposes only.

FY 2022
FY 2021
Cash and cash equivalents $4,430,208 $5,552,763
Investments $3,162,683 $4,144,242
Current pledges receivable, net $970,433 $35,000
Contributions receivable (rent), net $195,182 $582,099
Contracts receivable $3,528,538 $1,141,268
Inventories $315,985 $393,462
Unemployment trust deposits $128,572 $302,309
Prepaid expenses $364,127 $46,213
Total Current Assets $13,095,728 $12,197,356
Long-term portion of pledges receivable, net $355,448 $1,308,470
Property and equipment, net $1,228,420 1,227,762
Interest in 2100 Building $7,097,000
Endowment investments $5,189,663 $6,373,414
Total Long-Term Assets $13,870,531 $8,909,646
Total Assets $26,966,259 $21,107,002
Accounts payable $143,584 $286,030
Other liabilities  $266,444
 Accrued salaries and related costs  $829,883  $716,656
 Total Current Liabilities  $1,239,911  $1,002,686
Without donor restrictions  $19,743,171 $12,564,684
With donor restrictions $5,983,177 $7,539,632
Total Net Assets $25,726,348 $20,104,316
Total Liabilities and Net Assets $26,966,259 $21,107,002

Download Treehouse Financials: https://bit.ly/3OTmpO7 

Every balance sheet will begin with a summary of assets first. Assets are listed in reducing order of liquidity. What that means is that the most liquid asset appears first, and the least liquid assets appear near the bottom. We can convert an asset to cash by selling it or, in the case of receivables, collecting it. Cash is, of course, the most liquid asset. That is why it is listed first. Cash equivalents (including commercial paper and marketable securities like money market mutual funds and overnight repurchase agreements or “Repos”) are safe short-term investments that can be converted to cash immediately at low or no cost. Receivables will convert into cash as clients and donors make payments. Current assets that we do not expect to convert to cash quickly are listed below cash and receivables. Restricted assets are not considered liquid and are reported below the least liquid current asset (e.g., inventory or pre-paid expenses) or are not reported as current assets (e.g., endowment investments).

Treehouse reports the most typical current assets:

  • Investments include holdings of stocks, bonds, and other conventional financial instruments, including investments in mutual funds. Note that investments are reported separately from Endowment Investments (non-current), as the latter is subject to internal (board-designated) and external (donor-imposed) restrictions. Note that investments are reported separately from cash equivalents, as they are bought and sold less frequently. This, however, should not be confused with liquidity. A vast majority of financial investments are liquid. However, unlike cash equivalents, investments do not mature every 30 days or every three months; as a result, they need not be actively traded.
  • Receivables refer to money owed to the organization. When customers pay money owed to the organization, that asset converts to cash. Treehouse reports net receivables. This means it has subtracted from that receivables figure the portion of those receivables it has determined it cannot collect. Those removals are known as an allowance for uncollectible or bad debt expenses. The nonprofit reports pledges, rent, and contracts receivable separately. Pledges receivable represent a donor’s commitment to give at a future date. Rent receivable represents rent due from tenants in their building. Rent receivable is reported separately from contracts receivable to capture differences in the types of services provided.
  • Inventory includes goods that the organization intends to sell or give away as part of delivering its services. Much of Treehouse’s inventory is in “The Treehouse Store,” a thrift store where children can pick up clothing and personal items for free. Many organizations (Treehouse not included) report a separate category for supplies. These are goods and materials, usually commodities, that the organization intends to use while delivering its services. Unlike marketable securities and investments, there may not be a robust market for supplies and inventory, so they are among the least liquid current assets.
  • Pre-paid expenses are incurred when an organization opts to pay in advance for services (e.g., insurance, memberships, subscriptions) it will use later. If the organization cancels or renegotiates a pre-paid expense, a refund will be processed for the unused pre-paid amount. This is rare and is subject to contract restrictions.

Treehouse also reports the most common long-term assets. These are listed in decreasing order of liquidity:

  • Long-term receivables are monies owed to the organization to be received over multiple financial periods. This is especially true for grants, contracts, and pledges that are not in the current period. These long-term receivables are also reported as net of allowance for uncollectable or bad debt expenses. Long-term receivables must also be discounted to present value using the prevailing market interest rate. Recall that present value is the amount of money a future investment is worth today. Reporting long-term receivables in present value terms recognizes the foregone interest.
  • Fixed assets are the least liquid, as the organization’s ability to convert these assets into cash will incur costs and take time. Property and equipment are reported book value – that is, historical cost or purchase price, net of depreciation. Depreciation is the loss in value of an asset due to wear and tear. Effective December 2021, Treehouse became co-owner of its building when a portion of the property was donated to the organization. The Statement of Financial Position reports the fair market value of Treehouse’s share of the building at the time of the donation. Going forward, the value of the organization’s interest will be reported net of depreciation.


Accountants usually report assets at historical cost or the cost the organization paid to acquire them. For instance, if an organization purchased a building for $500,000 10 years ago, it would report a book value equal to the historical cost net of depreciation. Meanwhile, an appraiser might estimate that a buyer would be willing to pay $1,000,000 for that building today. This is the building’s estimated market value. Accountants prefer historical costs. In fact, that preference is so strong that it is called the historical cost rule of accounting. Until that building is sold for $1,000,000, that figure is just a guess that is too unreliable as a basis for financial reporting.
  • Endowment Investments represent donor-restricted funds. For that reason, endowment investments are frequently listed as non-current assets. Note that investments remain liquid – the classification as a non-current asset reflects restrictions on use. Investment earnings could be invested in the programs or services if donor restrictions do not apply. Treehouse reports endowment investments separately from its other investments and cash holdings. Not all non-profits will report investments this way. That said, they must disclose the different types of endowment funds (or donor-restricted net assets) in the notes to the financial statements.
  • Other Investments. Many investments are not liquid because their owner is not allowed to sell them. For example, venture capital funds, hedge funds, and private equity funds mandate lock-in periods. Investors trade off liquidity in these funds but expect higher investment returns. Some investments are less liquid because there are fewer potential buyers. Commercial real estate, for instance, can take some time to sell because there are fewer potential investors interested in those types of properties than in residential real estate. All these investments are reported as “other” long-term assets.


Investments are a notable exception to the historical cost rule. Most investments trade on an exchange like the New York Stock Exchange. The prices quoted in those exchanges are a reasonable estimate of the value of a stock or bond. Since we can readily observe that the fair market value or the value of the investment can be objectively obtained, we replace the historical cost with a fair value estimate. Assuming a non-profit purchased 1,000 shares of Apple stock in 2001 for $0.33 per share, the value of that portfolio, as of June 30, 2023, would have been $193,970. We adjust our books on an annual basis to recognize the gains or losses in the value of our investments. In this case, we would report the change in the investment value as the price of Apple stock increased by $55.86 from $138.11 on July 1, 2022, to $193.97 on June 30, 2023. Despite the considerable gain in the value, accountants are comfortable relaxing the historical cost rule because we objectively measured the value of the Apple stock.

In every balance sheet, liabilities are listed in increasing order of maturity. Maturity refers to the moment in time when payment is due. Said differently, liabilities are listed based on how quickly the organization will need to pay them. Treehouse’s balance sheet includes the two most common current liabilities: accounts payable and accrued salaries and related costs (i.e., wages payable). These are liabilities that will come due within the fiscal year. Like many non-profits, Treehouse does not report any long-term liabilities like a mortgage or a loan. If it had, it would list the proportion due in the next twelve months under current liabilities and the proportion due after that under non-current liabilities.

At a glance, three key features of Treehouse’s balance sheet stand out. First, its current assets far exceed the non-profit’s current liabilities. Its near-term financial position is robust, and the non-profit has more than enough cash to cover its obligations as they come due.

Every balance sheet will present a summary of the organization’s net position (equity, net assets, net position, or fund balance). In the case of Treehouse, a non-profit, its net position is reported in one of two categories: net assets “without donor restrictions” or net assets “with donor restrictions.” Net assets with restrictions include donor-restricted endowment funds (previously listed as permanently restricted) and contributions receivable that are restricted over time and/or use (previously listed as temporarily restricted). Board-designated quasi-endowment funds and accumulated profits are reported under net assets “without donor restrictions.”

The balance sheet shows Treehouse is in a strong financial position, has the right balance across its current and long-term assets, and does not have any long-term liabilities. It also has greater autonomy over its financial resources, as 76 percent of its net assets are not subject to donor restrictions.


GAAP imposes uniformity on how public organizations recognize and report their financial activity. But at the same time, all public organizations are a bit different. They have different missions, financial policies, tolerances for financial risk, and so forth. Moreover, large parts of GAAP afford organizations a lot of discretion on how and when to recognize certain types of transactions. For these reasons, numbers in the basic financial statements do not always tell the complete financial story about the organization in question. That is why it is essential to read the “Notes to the Financial Statements.” The notes are narrative explanations at the end of the financial statements. They outline the organization’s key accounting assumptions, share its key financial policies, and explain any unique transactions or other financial activity.


The Statement of Activities, the non-profit’s income statement, is designed to tell us if an organization’s programs and services cover its costs. In other words, is this organization profitable?

Every income statement will begin with a summary of revenues and a report of expenses, either by program or line time. In GAAP, revenue is what the organization earns for delivering services or selling goods. Expenses are the cost of doing business. Whenever possible, think of expenses in terms of the revenues they help to generate. For non-profit organizations, this relationship is sometimes clear and sometimes not. For example, imagine that a non-profit conservation organization operates guided backpacking trips. Participants pay a small fee to participate in those trips. To run those trips, the organization will incur expenses like wages paid to the trip guides, supplies, costs related to state permits, and so forth. These are expenses incurred while producing backpacking tour revenue. Here the relationship between revenues and expenses is clear.

This same organization might sell coffee mugs, water bottles, and other merchandise and then use those revenues to support its conservation mission. The expenses to produce those mugs are known as the cost of goods sold. Here again, the revenue-expense relationship is clear. When that link is clear, we can determine if a program/service/product is profitable. That is, does the revenue it generates exceed the expenses it uses up?

In for-profit organizations, profitability and accountability are virtually synonymous. But for public organizations, profitability has little to do with accountability. For instance, our conservation non-profit might accept donations from individuals in support of its conservation work. Which expenses were necessary to “produce” those revenues? The development director’s salary? The administrator’s travel expenses to visit a key donor? The expenses from a recent marketing campaign? Here, the revenue-expense link is less clear. Same for in-kind contributions (i.e., donated goods and services) the organization receives in support of its mission. This link is even murkier for governments, where taxpayers pay income, property, and sales taxes. Those taxes have no direct link to the expenses the government incurs to deliver police, fire, parks, public health, and other services.

To put this in the language of accounting, public organizations have a mix of exchange-like activities, such as backpacking trips and coffee mugs, and non-exchange-like activities, like conservation programs and public safety functions that are just as, if not more, central to their mission as their exchange-like activities. That is why profitability is one of the many criteria we need to apply when thinking about a public organization’s finances.

That said, the main point of emphasis on the income statement is the relationship between revenues and expenses. As mentioned, net assets are a good indication of that relationship. If revenues increase faster than expenses, then net assets increase. If expenses increased faster than revenues, net assets would decrease. The income statement can help illuminate several follow-up questions to understand an organization’s revenues-expenses relationship in some detail:

  1. How much did net assets increase since last year? How much of that increase was in net assets without donor restrictions? How much was in net assets with donor restrictions? Growth in net assets without donor restrictions indicates that the organization’s core programs and services are profitable. An increase in net assets with donor restrictions can mean many other things. It could mean the non-profit received additional donations that had a time or purpose restriction. The non-profit would need to meet those restrictions over multiple years. It could also mean the non-profit’s endowment reported a positive return. That return may be reinvested in the endowment or diverted to cover core operational expenses.
  2. What portion of revenue is from earned income versus contributed income? Earned revenue, or revenue generated when the organization sells goods or services, is attractive because managers have direct control of expenses needed to generate that income. Contributions are less predictable and less directly manageable but do not have an immediate offsetting expense – except for fundraising and development costs. That said, the disconnect between donor and beneficiary provides the non-profit with the ability to manage expenses given changes in contributions.
  3. What percentage of earned revenue is from the organization’s core programs and services? What proportion is from other activities and other lines of business (sometimes known as unrelated business income)? It is common for non-core programs and services to subsidize core programs and services, but is that the right policy for this organization to pursue? Non-profits that generate unrelated business income must pay UBIT – unrelated business income tax on profits earned from activities not substantially related to the charitable organization.
  4. To what extent does this organization rely on in-kind contributions? Investment income? In-kind contributions will vary by type of organization. Food banks are more likely to report in-kind contributions as a major source of revenue. Treehouse received an in-kind donation of an interest in their building. Professionals in legal, marketing, and accounting service industries frequently provide local non-profits with services for free or at steep discounts. These are reported as in-kind donations.

How much the non-profit reports as investment income largely depends on the size of the investment portfolio. Foundations, for example, will report investment income as the single largest source of revenue. In contrast, for most non-profits, investment income makes up a smaller portion of overall revenues. Still, it often allows the organization to report a surplus at the end of the fiscal year.

To illustrate, let us examine Treehouse’s Statement of Activities for the year ending June 30, 2022. The income statement reports revenues by source and by restriction and expenses by function (program, management, or fundraising). While Treehouse does not report expenses for each program, a detailed list of expenses can be found in the Statement of Functional Expenses.

Without donor restrictions
FY 2022 With donor restrictions
Without donor restrictions
FY 2021 With donor restrictions
Contributions and grants $9,400,113 $640,000 $10,040,113 $8,257,401 $350,000 $8,607,401
In-kind contributions $662,156 $662,156 $580.307 $271,968 $852,275
Contract revenue $12,659,996 $12,659,996 $3,867,313 $3,867,313
SBA PPP proceeds $137,164
Other revenue $23,358 $23,358 $137,164
Net assets released from restrictions $1,270,202 ($1,270,202) $878,350 ($878,350)
Total revenue $24,015,825 ($630,202) $23,385,623 $13,720,535 ($256,382) $13,464,153
Program services  $19,577,929  $19,577,929 $8,129,972 $8,129,972 
Management and general  $1,659,555  $1,659,555 $945,581 $945,581 
 Fundraising  $2,262,043  $2,262,043  $1,588,136  $1,588,136
Total expenses $23,499,527 $23,499,527 $10,663,689 $10,663,689
CHANGES IN OPERATING NET ASSETS $516,298  ($630,202)  ($113,904) $3,056,846  ($256,382)   $2,800,464
Investment income (loss) ($505,340) ($856,252) ($1,361,592) $127,859 $1,246,119 $1,373,978
Donation of interest in building 7,097,000 $7,097,000
Property related revenues $123,011 $123,011
Property related expenses ($122,486) ($122,486)
Total non-operating activity $6,592,185 ($856,252) $5,735,933 $127,859 $1,246,119 $1,373,978
TOTAL CHANGE IN NET ASSETS $7,108,483 ($1,486,454) $5,622,029 $3,184,705 $989,737 $4,174,442
NET ASSETS, beginning of year $12,634,688 $7,469,631 $20,104,316 $9,379,979 $6,549,895 $15,929,874
NET ASSETS, end of year $19,743,171 $5,983,177 $25,726,345 $12,564,684 $7,539,632 $20,104,316

Download Treehouse Financials: https://bit.ly/3OTmpO7

For FY 2022, Treehouse reported $23.4 million in revenues. Of that, $10.04 million was from contributions and grants, $0.7 million was from in-kind contributions, and $12.7 million from contract revenue. Most of Treehouse’s income is not subject to donor restrictions (i.e., without donor restrictions). Investment income, classified as non-operating revenues, is reported separately from operating revenues (i.e., grants, contributions, and contract revenue). Investment income would be classified as operating revenue in instances where the non-profit has invested a substantial proportion of its resources to generate income to support core programs or cover overhead costs. That is not the case for Treehouse.

Net assets released from restrictions represent a reclassification of net assets. That reclassification will appear as a reduction in net assets “with donor restrictions” and a corresponding increase in net assets “without donor restrictions.” In doing so, the non-profit is reporting it has satisfied the intent of the donation or grant received in the current or prior period. Remember, restrictions only apply to revenues; they do not apply to expenses, hence the need to release assets from restrictions.

In the expense part of the Statement, we see that expenses for program services were $19.6 million – approximately 83 percent of total expenses. Treehouse reports non-operating income separately from operating income, which indicates that income generated from investments and other sources was not derived from core activities. Not surprisingly, Treehouse reported investment losses at the end of FY 2022 ($1.4 million). It also reported the in-kind donation of an interest in the building ($7.1 million) as non-operating activity. In doing so, the organization conveys to stakeholders that it does not view this donation or related activities as part of its core operations.

Change in net assets is a focal point when reviewing the Statement of Activities. In FY 2022, Treehouse reported a positive change in net assets of $5.6 million. Much of this can be attributed to the in-kind donation of interest in a building ($7.1 million). Adjusting for the gift, Treehouse reported a deficit at the end of FY 2022. However, that deficit was primarily driven by investment losses – not the nonprofit’s core operations. Judging an organization’s performance using data from a single year is often difficult. Five years of data could provide a more compelling narrative of the organization’s financial position and operating results. More on this in Chapter 3.


Well, as one of us likes to say, it depends on a wide variety of factors, including revenue mix and volatility, timing of cash flows, changes in demand for services – particularly in an economic downturn – existing capital investments, and the need for capital improvements, to name a few. In creating reserves, a clear statement of purpose, size, and strategy to accumulate, expend, and replenish reserves should be discussed and adopted.
The Non-profit Finance Fund (NFF, see https://nff.org/fundamental/kinds-capital) recommends that non-profits create and accumulate reserves with specific goals in mind. Categories include (a) working capital reserves to ensure timely payment of obligations as they come due, (b) operating reserves used to absorb unforeseen revenue losses or unexpected extraordinary expenses, (c) risk and opportunity capital to support program development and innovation, (d) change capital that helps the organization address strategic issues including social justice, changes in government policies, or existential threats to operations (e.g., disruptive technology), (e) recovery capital to help recover from damaging financial shortfalls, reduce debt, or fund much-needed repairs to facilities and equipment, (f) facilities and equipment capital that finances the purchase of capital equipment or upgrades to existing infrastructure, and (g) endowments that generate investment income that can be used to support core programs or replenish reserves. Organizations need not establish each reserve, and one could argue that the categories are fluid. For example, some could consider operating reserves the same as recovery capital. Others are not. For example, working capital reserves allow the organization to cover program costs while payments from funders are pending. Working capital reserves are essential to every organization and are not the same as operating reserves. Every organization needs a working capital reserve, but not all organizations need recovery capital; therefore, the context of operations and environmental factors matter in creating and drawing on reserves.
How do you build and replenish reserves? Non-profits should budget for reserves. To ensure they meet that goal, they should include budget reserves as a line item in their operating budget or intentionally budget for a surplus. Capital campaigns would raise funds to fund capital improvements or create endowments. However, doing so could divert donations from operating activities. For that reason, the use of capital campaigns to create reserves should be strategic. Governments adopt similar approaches to build and replenish their “rainy-day” or “budget-stabilization funds.” More on this in Chapter 6.


The Statement of Cash Flows is just as the title suggests. It tells us how an organization receives and uses cash.

It might seem strange to devote an entire financial statement to a specific asset. But cash is not just any asset. Cash is king! For small organizations, especially small non-profits, it is possible to run out of cash. If that happens, nothing about that organization’s mission, clients, or impact on society will matter. Its employees, vendors, and creditors will not take a compelling mission statement as a form of payment. If the organization is out of cash, it is out of business.

To that end, the Statement of Cash Flows is quite useful if we want to answer a few key questions about how a public organization receives and uses cash:

  1. Did the organization’s core operations generate more cash than they used? If not, why?
  2. Did the organization depend on cash flow from investing or financing activities to support cash flows necessary for basic operations? How predictable are cash flows from investing and financing activities?
  3. How much of the organization’s cash is the result of transactions it cannot directly control (e.g., receivables)?
  4. How much of the organization’s cash flow is related to sales of goods and inventory? How predictable are those sales?

From the cash flow statement, we can learn a lot about the specific ways an organization generates and uses cash. The statement breaks cash flows into three categories: operations, investing activities, and financing activities. Euphemistically, we call this “OIF” (pronounced “oy-f”):

  1. Cash Flow from Operations presents a summary of how the organization receives cash and uses cash for its core activities. Negative cash flow from operations indicates that the organization’s basic operations use more cash than they produce. It could mean the organization reported profits because of growth in revenues – but those revenues remain uncollected and are reported as receivables. It could also be the case that the non-profit did not report a profit but reports positive cash flows from operations as a result of collecting outstanding receivables. While our discussion is focused on profitability, keep in mind that without positive cash flows from operations, the organization’s finances are not sustainable.
  2. Cash Flow from Investing Activities. In this case, investing includes investments in financial instruments or fixed assets like property and equipment. For most non-profits, this section is focused on cash earned from investments. If those investments produced more cash than what was spent to acquire them, they provide positive cash flow. Purchases of buildings and equipment are a cash outflow, and if the organization sells any buildings or equipment, the receipts from those sales also appear here as a cash inflow (though this is rare). In general, we expect positive cash flow from investing activities. It’s essential, however, to know the origins of that positive cash flow. If the organization sold a building, that might produce positive cash flow, but at the expense of its ability to deliver services in the future. It might see negative cash flow from investing activities if, for instance, it moves idle cash into short-term investments.
  3. Cash Flow from Financing Activities. Financing activities capture any cash the organization borrows to finance its operations. Most of the activity in this section has to do with borrowed money. For-profit entities use this section of the cash flow statement to show how issuing stock produces a cash inflow. For non-profits and governments, the cash inflow from issuing bonds or taking out a loan will appear here. For non-profits with an endowment or other permanently restricted net assets that produce unrestricted investment income, that cash flow will also appear here.

Like with the balance sheet and income statement, net assets are a key part of most public organizations’ cash flow statements, especially cash flows from operating activities. It might seem strange that net assets are the point of departure for a statement about cash, but it makes sense if we are willing to make a few assumptions.

Recall that the most common way for net assets to increase is for revenues to exceed expenses. To understand the cash flow statement, take this idea a step further. Assume that a public organization’s total cash will increase during a fiscal period if the cash inflows from its main operating revenues exceed the cash it pays out to cover its main operating expenses. The “cash flow from operations” part of the cash flow statement is based on precisely this idea. It starts with the assumption that an organization’s change in net assets is a good indicator of its cash flows from operations.

Change in net assets $5,622,029
Adjustments to reconcile change in net assets to net cash flows from operating activities
Depreciation $286,275
Donated investments ($336,936)
Net realized and unrealized losses (gains) on investments $1,568,107
Changes in allowance and discounts on receivables ($24,422)
Donation of interest in building ($7,097,000)
Changes in operating assets and liabilities 
Pledges receivable $42,101
Contribution receivable for rent $386,917
Contracts & other receivable ($2,387,270)
Inventories $77,477
Deposits held in trust $173,737
Prepaid expenses ($317,914)
Accounts payable 123,999
Accrued salaries and related costs $113,229
Net cash used in operating activities ($1,769.671)
Purchase of investments ($195,512)
Proceeds from sale of investments $1,129,561
Purchase of furniture and equipment ($286,933)
Net cash investing activities $647,116
CASH AND CASH EQUIVALENTS, beginning of year $5,552,763
CASH AND CASH EQUIVALENTS, end of year $4,430,208

Download Treehouse Financials: https://bit.ly/3OTmpO7

Most sizable public organizations follow this concept and report their cash flows from operations using the indirect method. This method starts with the Change in Net Assets, assuming that change is the result of cash flows from operations. But of course, not all changes in net assets are the result of positive or negative cash flow. Different transactions and accounting procedures can affect revenues or expenses without affecting cash flow. A typical example is depreciation. Depreciation is when an organization “uses up” some portion of an asset to deliver services. The portion of that asset’s value that is used up is recorded as a depreciation expense. Like all expenses, depreciation reduces net assets. But at the same time, there is no cash flow associated with depreciation. You will not find checks written to an entity called “Depreciation.” The same is true for changes in the value of an organization’s investments. Its stocks, bonds, and other investments can increase in value, but unless it sells those investments, that increase in value will not produce any positive cash flow. Depreciation and changes in the value of investments are both examples of reconciliations. These are transactions that affect net assets but do not involve a cash flow.

In FY 2022, Treehouse produced its Statement of Cash Flows using the indirect method. Treehouse reported a positive change in net assets or surplus at the end of FY 2022 ($5.6 million). Using the Statement of Cash Flows, we want to understand how core operations contributed to the nonprofit’s operating position ($5.6 million) and whether that operating position resulted in higher cash balances. Skip down to the row “Net cash flows from operating activities,” and you will see that in FY 2022, Treehouse’s operating activities resulted in a net cash outflow of $1.8 million. In other words, while the nonprofit reported a large surplus, that surplus did not result in an increase in cash. In fact, core operations resulted in a $1.77 million decrease in cash balances.

To appreciate these differences, review the reconciliations reported under “Adjustments to reconcile change in net assets to net cash flows from operating activities.” Recall that the figures in this part of the statement are reconciliations, so we interpret them inversely. Any activity that decreases net assets is shown here as a positive value because we are “adding back” those activities to arrive at Net Cash Flows from Operations. Any activity that would increase net assets is shown as a negative value (or in parentheses) because we are “backing out” those activities to arrive at Net Cash Flows from Operations.

Treehouse reported several reconciliations in FY 2022. Treehouse reported $286,275 in depreciation expense. Depreciation expenses decrease net assets. We add back deprecation to the Change in Net Assets to arrive at Net Cash Flows from Operations – i.e., the estimate of the change in cash flows from operating activities.

Treehouse reported an increase in discounts and allowances for uncollectables of $24,422. That increase in discounts and allowances decreases Change in Net Assets. We reconcile this item by backing out the change in allowances.

Treehouse received $336,936 in donated investments and $7.097 million in donated interest in the 2100 building. These transactions increase net assets (or profitability) but do not produce a positive cash flow. We deduct (or back out) contributed property and investments from Change in Net Assets. The same logic applies to realized and unrealized losses (gains) on investments. Treehouse reported $1,568,107 in investment losses at the end of FY 2022. Since these cash flows are restricted, and all cash flows are reported under investments – not cash – we add (or deduct) back that loss (gain) from Change in Net Assets.

Below the reconciliations, you will see “Change in Operating Assets and Liabilities.” The figures listed here are also reconciliations, this time to reconcile changes in assets and liabilities that do involve cash to Changes in Net Assets. The key here is that we are focused on changes in assets and liabilities as a result of cash flows. So, to make sense of the Change in Operating Assets and Liabilities section, first, think about how typical assets and liabilities interact with cash.

Cash balances are lower if assets other than cash are higher. If, for example, receivables are higher this year compared to the previous year, cash balances will be lower – in other words, the payment we should have received for a donated pledge or services provided has yet to be received. Consider contracts and other receivables. In FY 2022, contracts receivable was $3,528,538. In FY 2021, contracts receivable was $1,141,268. The increase in receivables implies that payments were pending, so our cash balances are $2,387,270 lower. The same logic applies to prepaid expenses, which increased from $46,213 at the end of FY 2021 to $364,127 at the end of FY 2022. The same logic applies when assets other than cash and investments increase. For example, balances in contributions receivable in FY 2022 were $195,182 – $386,917 lower than they were in FY 2021 ($582,099). That reduction resulted in an increase in cash. The same logic applies to inventories and unemployment trust deposits.

Increase in an asset account Decrease in Cash & Cash Equivalents
Decrease in an asset account Increase in Cash & Cash Equivalents
Increase in a liability account Increase in Cash & Cash Equivalents
Decrease in a liability account Decrease in Cash & Cash Equivalents

Cash balances are higher if balances in liability accounts are higher. Given the focus on Net Cash Flows from Operations, we focus here on accounts payable, other liabilities, and accrued salaries and related costs. As we noted earlier, any change in balances of any notes payable or loan payable would be reported in Net Cash Flows from Financing Activities. More on this below.

Consider Accounts payable. In FY 2022, accounts payable were $143,584, nearly half the balance reported at the end of FY 2021 ($286,030). This decrease in payables implies payments were made, as such, cash balances are $142,446 lower. Conversely, balances in other liabilities and accrued salaries and related costs were higher in FY 2022. Delayed payments mean the non-profit holds more cash now, so cash balances are higher ($266,444 and $113,227, respectively).

The Cash Flows from Investing Activities and Cash Flows from Financing Activities sections are more intuitive. Like before, an increase in an asset account reported under Investing Activities (e.g., Investments or Property and Equipment) results in a decrease in cash and cash equivalents and vice versa. An increase in a liability account reported under Financing Activities (e.g., Loan Payable) results in an increase in cash.

Returning to Treehouse, we see that in FY 2022, it purchased $286,933 in furniture and equipment and $195,512 in investments. The nonprofit reported the sale of investments ($1,129,561). The net effect of investing activities was $647,116 – in other words, investing activities (including the sale of investments) increased the cash position of the nonprofit.

Treehouse did not report any Cash Flows from Financing Activities. It did not report any long-term obligations, did not draw on any line of credit, and did not rely on borrowed funds. This reflects the nonprofit’s strong financial position but also the choice of the board to use internal resources to manage its cash position.

We can draw two immediate and important conclusions from Treehouse’s Statement of Cash Flows. First, the non-profit reported a large surplus ($5,622,029). While there were changes in account balances related to the non-profit operating activities, those activities did not generate cash. As a result, net cash flows from operating activities are negative ($1,739,671). The nonprofit relied on proceeds from the sale of investments to improve the organization’s cash position. At the end of FY 2022, the nonprofit’s cash position had declined from $5,552,763 at the start of the year to $4,430,208 at the end of the year. While the cash position has declined, it’s important to contextualize those findings. The nonprofit reported a large surplus because of a significant increase in revenues and the value of donations (investments and interest in building). While the nonprofit does not expect to liquidate the donated space, the contracts and other receivables should be collected in the next 12 months, improving the nonprofit’s cash position.

Statement of Functional Expenses

One of the central questions in non-profit financial management is: How well does this organization accomplish its mission? From a financial standpoint, one way to answer this question is to determine how much of the organization’s expenses are related to its core, mission-related services. In the language of accounting, this distinction is program services vs. support services (i.e., administrative services). According to paragraph 28 of FASB Statement 117, program services are “activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the organization exists.” Support services are everything else: fund-raising, communications, management, administrative support, and other activities necessary to deliver program services.

Donors want to support a non-profit’s primary goals. They want to know if their contribution improved a child’s education, fed the hungry, funded scientific research, or advanced objectives outlined in the organization’s mission. They are less interested in funding rent, insurance, professional memberships, administrators’ salaries (gasp!), or other support services. To be clear, support services are essential. They’re just not sexy. That is why one of the most closely watched numbers in non-profit financial management is the program expense ratio, computed as total program service expenses/total expenses. Many donors look for organizations with comparatively high program expense ratios, and many non-profit leaders work hard to minimize their support service expenses for that same reason.

The program services vs. support services distinction is so important that GAAP calls for a fourth basic statement to illustrate it. This statement is called the Statement of Functional Expenses. It shows three basic categories of expenses:

  1. Program. Many non-profits report their program expenses separately for each of their major mission or programmatic areas.
  2. Management and General are principally salaries and benefits for administrators, technical support services like accounting and information technology, and reconciliation expenses in areas like depreciation.
  3. Fundraising includes expenses related to fundraising and special events, identifying and contacting donors, and other expenses associated with soliciting and generating contributions.

Enrichment Programs

Education Programs

Free Store


Total Program Services

Management and General


Total Support Services


Payroll $4,395,285 $314,944 $3,256,070 $7,966,299 $534,943 $1,489,412 $2,024,355 $9,990,654
Payroll taxes and benefits $1,095,975 $73,316 $689,588 $1,858,879 $153,356 $158,137 $311,493 $2,170,372
Free store & holiday magic $805,346 $805,346 $805,346
Assistance to specific individuals $5,740,043 $5,740,043 $5,740,043
Occupancy $240,000 $167,947 $407,947 $52,778 $5,090 $57,868 $465,815
Professional services $301 $22,191 $1,161,957 $1,184,449 $584,639 $276,936 $861,575 $2,046,024
Transportation $59,528 $3,277 $41,356 104,161 $6,351 $1,360 $7,711 $111,872
Licenses and fees $16,886 $820,303 837,189 $202,811 $12,623 $215,434 $1,052,623
Special events $109,479 $109,479 $109,479
Depreciation $4,745 $230,364 $235,109 $49,030 $2,135 $51,165 $286,274
Supplies $22,130 $8,903 $28,496 $59,529 $2,435 $5,639 $8,074 $67,603
Printing and publications $797 $620 $19,818 $21,235 $24,781 $37,681 $62,462 $83,697
Postage and shipping $521 $12,335 $77,715 $90,571 $12,080 $479 $12,559 $103,130
Staff training $2,607 $2,158 $114,428 $119,193 $14,208 $11,186 $25,394 $144,587
Credit card fees $5 $8,716 $8,721 $30 $108,775 $108,805 $117,526
Insurance $1,582 $76,785 $78,367 $8,857 $8,198 $17,055 $95,422
All other operating expenses $7,621 $6,182 $47,088 $60,891 $13,256 $34,913 $48,169 $109,060
Total operating expenses – 2022 $5,584,765 $1,512,490 $12,480.674 $19,577,929 $1,659,555 $2,262,043 $3,921,598 $23,499,527

Download Treehouse Financials: https://bit.ly/3OTmpO7

Let’s return to Treehouse and examine its Statement of Functional Expenses. Treehouse reports expenses for each of its main programs in the first three columns from the left.

Education programs are by far the largest spending area. In FY 2022, Education programs were $5.6 million, or 23.7 percent of the organization’s total expenses. The previously mentioned Treehouse Free Store program expenses were $1.5 million (6.4 percent of total spending), and all “other” programs were $12.5 million (53.1 percent of total expense).

Total expenses in all program services in 2022 were $19.6 million, or 83.3 percent of total spending. In other words, the program service ratio is 83.3 percent. To put it one more way, 83 cents of every dollar Treehouse spends goes directly to fund the organization’s core programs.

One appealing feature of the Statement of Functional Expenses is that the expense categories are intuitive. Items like payroll, payroll taxes and benefits, occupancy (i.e., expenses related to maintaining buildings), licenses and fees, and transportation are self-explanatory.

Like many other human services-focused non-profits, most of Treehouse’s spending on support services is for fund-raising, and most of its spending on support services overall is for payroll. The same applies to spending on education programs. All these functions are labor-intensive.


The basic financial statements of state and local governments include four sets of financial statements.

  • Government-wide statementsStatement of Net Position and Statement of Activities that report on the government as a whole and with a long-term focus.
  • Fund Statements, including the:
    • Governmental fund statements – the Balance Sheet and Statement of Revenues, Expenditures, and Changes in Fund Balance report on activities financed with revenues from taxes, intergovernmental transfers, and other non-exchange or non-market transaction-based revenue sources with a short-term focus.
    • Proprietary fund statements – the Statement of Net Position, Statement of Revenues, Expenses, and Changes in Net Position, and Statement of Cash Flows report on business-type activities of the government that are financed primarily with user charges and fees with a long-term focus.
    • Fiduciary fund statements – the Statement of Net Position and Statement of Changes in Net Position that account for funds held by the government in a trustee or agency capacity.


Governments prepare government-wide financial statements that are like the basic financial statements for a non-profit or for-profit entity. Government-wide statements help users assess the finances of the government in its entirety. These government-wide statements answer key questions taxpayers ask about their government:

  • Has the government’s overall financial position improved or deteriorated?
  • Were its current-year revenues sufficient to cover the full costs of services?
  • How much did the government invest in infrastructure and other capital improvements?
  • How much does it depend on user fees and other exchange-like revenues compared to general tax revenues?
  • How does its financial position compare to other, similar governments?

To illustrate, let’s look at the financial statements for the City of Bothell, WA. The City of Bothell, part of the Seattle metropolitan area, is in King and Snohomish counties. In 2021, its population was just under 48,920.


Let’s start with Bothell’s government-wide balance sheet, formally known as the Statement of Net Position. It shows Bothell’s balances for its assets, liabilities, and net position on the final day of its fiscal year (December 31, 2021). This statement includes separate presentations for governmental activities and business-type activities. Taxes and other non-exchange revenues support governmental activities. Business-type or proprietary activities are supported by exchange-like revenues or fees the government charges for goods and services it delivers. For local governments, government-owned utilities (water, gas, electric, sewer, solid waste), recreational facilities (e.g., convention centers, golf courses, hotels, swimming pools, ice arenas, etc.), and other enterprises are almost always considered business-type activities. For state governments, business-type activities often include state lotteries, unemployment benefit funds, workers’ compensation funds, university tuition assistance programs, public hospitals, universities, community colleges, and public authorities supporting housing and economic development, to name a few.

On the asset side, we see many of the same assets reported in the Statement of Financial Position for Treehouse. The city of Bothell reports cash and cash equivalents, investments, receivables, restricted assets, and capital assets (non-depreciable and depreciable). Recall assets will be listed in reducing order of liquidity – the most liquid assets, cash and cash equivalents, are reported first, and the least liquid assets – capital assets (or infrastructure investments) and net pension assets – are listed last.

Governments will report amounts owed to the city for goods or services (e.g., outstanding payments for licenses, permits, fines, rents, royalties, or charges for services) separately from amounts due from taxes. Taxes receivables consist of property taxes and related interests and penalties the city of Bothell was owed at the end of 2021. Keep in mind that governments will report receivables for special assessments (a surtax in addition to the regular property tax) separately from taxes receivable as funds are used to fund specific activities (e.g., sidewalks, street lighting, economic development activities, etc.). Governments will also report receivables due from other governments. These capture inter-local agreements or cross-jurisdictional sharing arrangements common in areas like transit, emergency management, police and fire response, and public health.

It is important to note that this is the only financial statement that will report the value of the government’s investment in infrastructure or capital assets. Capital assets may be reported by type (e.g., land, buildings, leased assets, infrastructure, etc.) or classification (e.g., depreciable versus non-depreciable). Capital assets are reported at historical costs. Depreciable capital assets are reported net of depreciation.

Liabilities are listed in increasing order of maturity. Maturity refers to the moment in time when payment is due. The proportion due in the next twelve months is reported under “due within one year.” The accounts payable, unearned revenue, long-term liabilities, and other post-employment benefits due within one year are considered current liabilities. The remainder is non-current.

The city reported unearned revenue, sometimes referred to as deferred revenue. Unearned revenues represent revenues the government has received for services it has yet to provide. If the city fails to provide services, it will need to issue refunds. If the city owed another government based on an inter-local agreement, that obligation would appear here as due to other governments.

The city reports long-term liabilities, other post-employment benefits (OPEB), and net pension liability. Long-term liabilities include a variety of bonds (general obligation and revenue), as well as loans and leases associated with capital improvements. State and local governments finance most of their infrastructure improvements with long-term loans, bonds, notes, and leases that are paid off over 20 to 30 years. Cities, counties, and school districts rarely cease operations, even when they go bankrupt, so investors are willing to invest in them for long periods. It is quite different for non-profits or for-profits, where the going concern question is not always so clear.

Net pension liability represents the net obligation of retirement benefits the government owes its current employees, retirees, and beneficiaries. It represents the difference between the present value of projected retirement benefits and the plan assets, mainly financial investments. A net pension liability is reported if the current value of investments is less than the present value of projected benefits. If the current value of investments is greater than the present value of projected benefits, a net pension asset is reported. A majority of governments report pension and OPEB liabilities. OPEB (also known as other-post employment benefits) liabilities represent the net obligation of benefits other than pension benefits (principally healthcare benefits – including medical, dental, vision, hearing, death benefits, life insurance, disability, and long-term care) a government owes its employees and retirees. While governments have consistently funded their pension plans, few have set aside funds to meet their OPEB obligations. This is true for the city of Bothell – which reported $1.5 million in net pension liabilities and more than $6.5 million in OPEB obligations at the end of FY 2021.

Governmental Activities Business-Type Activities Total
Cash and cash equivalents $43,625,978 $3,098,118 $46,724,096
Investments $52,673,731 $18,962,038 $71,635,769
Receivables (net) $14,129,337 $2,944,749 $17,074,086
Taxes receivables $577,654 $577,654
Restricted assets:
Deposit held in trust $277,395 $277,395
Investment $1,316,369 $1,316,369
Capital assets:
Non-depreciable $190,905,806 $5,381,078 $196,286,884
Depreciable, net $410,067,171 $57,208,806 $467,275,977
Net pension asset $40,016,250 $2,575,986 $42,592,236
Total assets $752,273,321 $91,487,144 $843,760,466
Deferred outflows – pension $4,183,827 $297,567 $4,481,394
Deferred outflows – other postemployment benefits (OPEB) $66,836 $66,836
Total  deferred outflows of resources $4,250,663 $297,567 $4,548,230
Accounts payable $8598,730 $797,056 $9,395,786
Unearned revenue $6,687,001 $6,687,001
Long-term liabilities (see Note 13)
Due within one year $8,391,210 $1,209,592 $9,600,803
Due in more than one year $109,404,132 $14,040,304 $123,444,436
Total other postemployment benefits (OPEB)
Due within one year $197,584 $197,584
Due in more than one year $6391,449 $6391,449
Net pension liability – due in more than one year $1,489,772 $1,489,772
Total liabilities $141,159,878 $16,046,952 $157,206,831
Deferred inflows – pension $28,361,837 $2,417,444 $30,779,281
Deferred inflows – advanced grant $12,909 $12,909
Total deferred inflows of resources $28,361,837 $2,430,353 $30,792,190
Net investment in capital assets $10,712,545 $47,625,783 $558,338,328
Restricted for:
Pension $17,541,429 $443,200 $17,984,630
Transportation $4,778,189 $4,778,189
Parks & Recreation $5,872,879 $5,872,879
Capital projects $20,131,126 $20,131,126
Street maintenance $4,902,348 $4,902,348
Drug forfeitures $205,570 $205,570
Fire impact fees $450,164 $450,164
Public safety levy $6,113,168 $6,113,168
Debt service $3,974 $1,316,369 $1,320,343
Firefighter’s pension $369,116 $369,116
Cemetery (permanently restricted) 16,321 16,321
Other purpose $628,105 $628,105
Unrestricted $15,277,335 $23,922,054 $39,199,389
Total net position $587,002,269 $73,307,406 $660,309,675

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB

Below total assets and total liabilities are two new categories of deferrals – deferred inflows of resources and deferred outflows of resources. A government records a deferred inflow of resources when it receives resources as part of a non-exchange transaction in advance. Pre-paid property taxes are a good example. Imagine a property owner in Bothell who paid property taxes for 2022 in October of 2021. The City of Bothell might be tempted to call this deferred revenue because it received payment in advance for services it will deliver next year. However, that would be incorrect because property taxes are a non-exchange revenue. Taxpayers in Bothell do not pay property taxes for specific services at specific times; they pay for a variety of services delivered at various times throughout the year. There is no real exchange. In this case, the city would recognize the taxpayer’s payment as an asset but simultaneously recognize a deferred inflow of resources. Next year, when the city delivers services funded by property taxes, it will reduce cash and reduce that deferred inflow.

The inverse is true for deferred outflows. Say, for example, that most of the city’s employees belong to the public employee retirement system (there are several, including PERS 1, PERS 2/3, PSERS 2, LEOFF 1, LEOFF 2). The pension systems, collectively administered by the State of Washington, send the city a bill for $2.7 million to cover pensions and other costs related to the city’s employees. That bill is due on January 20, 2022. If, before the city closes its books on December 31, 2021, the city council signs papers acknowledging its commitment to making that $2.7 million payment shortly after the start of the coming fiscal year, those resources are effectively unavailable for the following year. The City of Bothell might be tempted to classify this under accounts payable because it owes money. But that is not entirely true. A state retirement system is not a service, and even if it were, it would not deliver that service until the next fiscal year. Instead, the city will book this as a deferred outflow of resources and book a corresponding increase in liabilities. By not booking a liability and not spending the cash, the city’s balance sheet looks much stronger. At the same time, it has committed resources to the future, which will impact its operations in the coming year. By recognizing a deferred outflow of resources, the city has offered us a clearer picture of how well the resources it collects each year cover its annual spending needs.

With the addition of deferrals, we re-write the fundamental equation for the government-wide financial statements as

Assets + Deferred Outflows = Liabilities + Deferred Inflows + Net Position

In the traditional fundamental equation, we use “net assets” to identify assets minus liabilities. When we add deferrals, the “net assets” label no longer captures everything on the right side of the equation, but “net position” does. Net position and its components are also a uniquely governmental reporting feature. Here, Bothell’s net position is similar to other states and local governments.

  • Net Investment in Capital Assets is the historical cost of capital improvements or infrastructure investments – net of depreciation – and debt associated with the acquisition, construction, or improvement of capital assets. All capital assets are reported in this component of net assets, even if there are legal or other restrictions on how the government uses them for service delivery.
  • Governments restrict portions of their net position for many purposes. Restricted net position is virtually the same as restricted net assets for a non-profit. According to governmental GAAP, a portion of net position is restricted if: 1) an external body, like bondholders or the state legislature, can enforce that restriction, or 2) the governing body passes a law or other action that imposes that restriction. If there are assets that are restricted, that restriction will be reported in the net position. The city reports a restricted net position for a wide variety of activities, including transportation, parks, and street maintenance. These restrictions are based on laws adopted by the governing board or contracts with an external third party (e.g., bondholders).
  • The government’s unrestricted net position is akin to a non-profit’s unrestricted net assets. These are net assets available for spending in the coming fiscal year. A negative unrestricted net position occurs if liabilities exceed assets. This does not mean the government is on the brink of fiscal disaster. It simply means the government’s non-current liabilities, particularly retiree benefit obligations, far exceed its unrestricted non-capital assets. Governments reporting a sizeable unfunded liability are more likely to report a negative unrestricted net position.


When we look at Net Investment in Capital Assets, we are forced to evaluate the “book value” of a capital asset. Recall that most organizations – public and private – record their tangible capital assets at historical cost. That means they record a new asset at whatever it cost to construct or purchase it and then depreciate it over its useful life. Most of the fixed assets non-profits carry on their books – buildings, vehicles, office furniture, etc. – have useful lives of 10-30 years. But how does a government determine the book value of a street? Or a school building? Or a sewer system? Many were built long before governments started preparing modern financial statements, and many of them have useful lives of more than 100 years.
States and localities dealt with precisely this issue when they implemented Governmental Accounting Standards Board (GASB) Statement 34. This statement, euphemistically known as “GASB 34,” required governments to report the book value of their capital assets. Prior to GASB 34, governments reported what they spent each year on capital assets as an expense, but they did not include their full book value. In other words, they did not capitalize on their infrastructure assets.
Fortunately, many governments were able to reconstruct historical cost figures by reviewing old invoices, purchase orders, construction plans, and other documents. Public works staff at state and local governments around the country spent thousands of hours researching old records to determine what they spent to build their original streets, bridges, sewer systems, university buildings, and other key pieces of infrastructure. Those assets were then grouped into fixed asset networks, assigned a useful life and a depreciation schedule, and depreciated to the present day. That depreciated figure became the original capitalized infrastructure asset value.
So, for most governments, the figure Net Investment in Capital Assets is the original capitalized value depreciated to a present-day value, plus any investments since implementing GASB 34. A few governments take a different approach allowed under GASB 34, known as the modified method. Here, a government capitalizes its infrastructure assets, but instead of depreciation, it estimates how much it will need to spend each year to maintain those assets in good working condition. If it can demonstrate that it’s making those investments, it need not depreciate, and the book value does not change.
Why take the time and effort to do this? Because investors and taxpayers want to know if the government is taking care of its vital infrastructure. If the Net Investment in Capital Assets is stable or increasing, it suggests a government is precisely making those investments.


A government’s Statement of Activities presents much of the same information we see on the income statement for a for-profit or non-profit. It lists a government’s revenues and expenses or expenditures and the difference between them. It reports the change in net assets or net position and explains why that change happened. Like an income statement, it tells us where the government’s money came from, where it went, and whether its core activities pay for themselves.

That said, the Statement of Activities is also quite different from a traditional income statement. Expenses in the upper left are presented first. These are listed by function or program, with the governmental activities presented separately from the business-type activities. Recall that governmental activities are those supported by taxes and other non-exchange revenues. In contrast, business-type activities are supported with exchange-like revenues, primarily user charges and fees. Governmental activities and business-type activities together comprise the primary government. Next to expenses, you may occasionally see (although not with Bothell) indirect expenses the government has allocated to each activity (more on this in Chapter 5).




Charges for Services

Operating Grants and Contributions

Capital Grants and Contributions

Governmental Activities

Primary Government Business-Type Activities


Primary government
Government activities
General government $18,943,497 $6,079,031 $795,460 ($12,069,005) ($12,069,005)
Security of persons and property $26,724,920 $6,829,797 $2,067,268 ($17,827,855) ($17,827,855)
Physical environment $2,154,053 $1,625,408 $111,151 ($417,495) ($417,495)
Transportation $50,610,973 $752,450 $996,532 $12,354,275 ($36,507,716) ($36,507,716)
Culture and recreation $2,098,286 $287,202 $6,080 $308,993 ($1,496,011) ($1,496,011)
Interest $3,933,715 ($3,933,715) ($3,933,715)
Total governmental activities $109,363,047 $26,765,193 $4,085,772 $12,663,267 ($65,848,816) ($65,848,816)
Business-type activities
Water $5,623,205 $6,342,408 $241 $382,712 $1,102,156 $1,102,156
Sewer $7,747,885 $8,851,058 $198 $289,043 $1,392,414 $1,392,414
Storm & surface water $5,733,509 $6,908,221 $7,324 $1,094,538 $2,276,575 $2,276,575
Total business-type activities $19,104,599 $22,101,687 $7,763 $1,766,293 $4,771,144 $4,771,144
Total primary government $128,467,646 $48,866,880 $4,093,535 $14,429,560 ($65,848,816) $4,771,144 ($61,077,671)
General revenues
Property taxes $27,025,250 $27,025,250
Sales taxes $19,298,152 $19,298,152
Excise taxes $8,623,599 $8,623,599
Business taxes $7,261,144 $7,261,144
Interest and investment earnings $108,963 $6,428 $115,391
Miscellaneous $1,027,883 $270,009 $1,297,893
Transfers $408,265 ($408,265)
Total general revenues and transfers $63,753,256 ($131,828) $63,621,428
Change in net position ($2,095,559) $4,639,317 $2,543,757
Net position – beginning $589,097,828 $68,668,090 $657,765,918
Net position – ending $587,002,269 $73,307,406 $660,309,675

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB

Program revenues include (a) charges for services, (b) operating grants and contributions, and (c) capital grants and contributions. Charges for services include revenues based on exchange or exchange-like transactions that can be directly linked to programs. For example, the city of Bothell reported $6.1 million in charges under General Government. Revenues were from the sale of licenses and permits. The $6.8 million in charges reported under the Security of persons and property include anything from fees for fire protection and emergency medical services to civil penalties, including parking fees and traffic violations. Charges for services will vary by type of government and scope of activities. The city reported $4.1 million in operating grants and contributions and $12.7 million in capital grants and contributions. A significant proportion of the capital grants and contributions were in Transportation. Business-type activities similarly reported operating ($7,763) and capital ($1.8 million) grants and contributions.

Shifting to the right, we see columns with the heading “Net (Expense) Revenue and Changes in Net Position.” The net cost format nets program revenues from expenses. The city reports a net expense of $12,069,005 for the General government. This figure represents the sum charges for services, operating grants and contributions, and capital grants and contributions minus expenses (($6,079,031 + $795,460 + $0) – $18,943,497). This deficit (or net expense) tells us that general government activities do not pay for themselves. Similarly, public safety programs (police, fire, emergency medical services) do not pay for themselves (-$17,827,855). Governmental activities are not self-sustaining. Except for the “economic environment,” every program reported a net expense (or deficit) – for a total of $65.9 million.

Should the city council be concerned that its core services are hemorrhaging money? Not really. We do not want local government services like public safety, planning, and zoning to pay for themselves because there is no clear link between the users and the beneficiaries of these services. The city exacts fines on people who break the law when they park illegally or speed on city streets, but those fees are designed to deter those behaviors. Perpetrators who pay these fines do not receive a service, and as we saw in Ferguson, MO, and elsewhere, bad things happen when local governments turn fines into a viable revenue source.

But that leaves open an important question. Citizens want to see these essential services provided. How, then, do we help fund public transit or public safety?

To answer that question, skip down to the lower right corner of the statement. Here we see a list of General Revenues like property taxes, sales taxes, excise taxes, business taxes, and other revenues. General revenues are not directly connected to a specific activity. The city of Bothell reported $63.8 million in general revenues for FY 2021. Compare that figure to the $65.9 million in net expense for governmental activities – we are left with a decrease in the government’s net position for governmental activities of $2.1 million. The city’s total revenues (taxes, charges and fees, and grants) were not sufficient to cover its expenses.

Should the city council be concerned with this figure? Well, it depends. We need to understand whether the negative change in net position resulted from a decline in revenues, an increase in expenses, or both. We also need to understand whether the changes resulted from changes in the economic environment, tax policy, or accounting standards. The answer, sometimes, is not as straightforward. As you will see in Chapter 3, more questions than answers will arise from any review of financial statements. That said, the relationship between expenses, program revenues, and general revenues is one of the most important things to observe in a government’s Statement of Activities.

The expense versus program revenues link is much more straightforward for business-type activities. Recall that business-type activities are designed to pay for themselves through charges and services. For the city of Bothell, Water, Sewer, and Storm Water reported net revenue of $4.8 million at the end of FY 2021. Their operations were not subsidized with tax revenues.

Not all business-type activities are self-supporting, and not all business-type activities consistently report a surplus. For example, public universities and hospitals listed under business type are frequently subsidized with tax revenues. States will report transfers to business-type activities to finance the operations of its universities and hospitals. The unemployment benefits program is another example of a program that reports sizeable surpluses when unemployment rates are low but reports sizeable deficits when unemployment rates are high, as benefit distributions in a recession will exceed program revenues. So again, it depends!

That said business-type activities present challenging strategic and policy questions. How profitable is too profitable? Moreover, should business-type activities subsidize governmental activities? If a business-type activity like a golf course is not profitable, does it offer enough indirect benefits in areas like economic development and tourism to justify that lack of profitability? With a careful look at the Statement of Activities, you can begin to put numbers to these and other questions.


A component unit is a legally separate entity for which the government is financially accountable. The primary government is financially responsible if it can appoint a voting majority to the unit’s governing body, if the component unit can impose financial burdens on the primary government, or if the unit is fiscally dependent on the primary government. Special districts like local development authorities, transportation improvement districts, and library districts are typical local government component units. Component units reported by larger governments, including states, include housing authorities, tollway authorities, public insurance corporations, state lotteries, and state universities.
Most component units are small relative to the primary government. But some are pretty large. The Cherokee Nation of Oklahoma (www.cherokee.org), for example, counts among its component units three casinos, a housing development company, a home health services company, a public health insurance company, a waste management company, a large community foundation, a historic preservation society, and an economic development corporation, among others. At the end of FY 2022, total revenues from the primary government were $2.17 billion. Revenues of the various components of the Cherokee Nation were $2.14 billion.


A fund is a stand-alone, self-balancing set of accounts with a specific purpose. Funds are one of our main tools to assess a government’s fiscal accountability. Fiscal accountability is the responsibility of governments to justify that their actions in the current period have complied with public decisions concerning the raising and spending of public money (GASB Statement 34). That responsibility is fundamental to financial reporting and why governments prepare separate fund-based financial statements. They include:

  1. Governmental Fund Statements that report on activities financed primarily with revenues from taxes, intergovernmental transfers, and other non-exchange or non-market transaction-based revenue sources. Governments will prepare a Balance Sheet and a Statement of Revenues, Expenditures, and Changes in Fund Balances for the governmental funds.
  2. Proprietary Fund Statements, which report on business-type activities of the government that are financed primarily with user charges and fees. Financial statements include a Statement of Net Position, a Statement of Revenues, Expenses, and Changes in Net Position, and a Statement of Cash Flows.
  3. Fiduciary Fund Statements account for funds held by the government in a trustee or agency capacity. Governments will prepare a Statement of Net Position and a Statement of Changes in Net Position.


The governmental fund statements are prepared on a different basis of accounting, known as modified accrual accounting. Modified accrual accounting is designed to reflect this unique focus on short-term fiscal accountability. To that end, we rewrite the fundamental equation of accounting for the modified accrual context as follows

Assets + Deferred Outflows = Liabilities + Deferred Inflows + Fund Balance

In the governmental fund statements, we care most about fund balance – the difference between assets and liabilities in each fund. Fund balance is the most closely watched number in all governmental accounting. Taxpayers seem to understand that if a government is living within its means, then its assets should be greater than its liabilities, and it will report a positive fund balance. Policymakers seem to understand that ending the fiscal year with a positive fund balance means there is a bit of money to spend in the next fiscal year. That’s why many fiscal policy and financial strategy discussions often come back to a simple “Goldilocks” question: Is our general fund balance too large, too small, or just right?

It is important to note that the change to reporting on a modified accrual basis does not apply to proprietary or fiduciary fund statements. In fact, proprietary and fiduciary fund statements are prepared using the same accounting basis used to prepare government-wide statements. So why prepare an additional set of financial statements if the same basis of accounting applies? Again, the idea goes back to the responsibility of governments to fulfill their fiscal accountability responsibility. More on this below.

Fund Structure – City of Bothell
A chart depicting Bothell's fund structures. The three main categories include governmental funds, proprietary funds, and fiduciary funds.
*The “Combining Financial Statements” are included in the Required Supplementary Section of the Annual Comprehensive Financial Reports (ACFRs) and provide details on each non-major fund. For the city of Bothell, there were no non-major funds in the Proprietary Fund.

The governmental fund statements report on a fund basis on activities in the general fund, special revenue funds, capital projects funds, debt service funds, and permanent funds. The city of Bothell reports fourteen separate funds in the governmental fund statements, four in its proprietary fund statements, and two in fiduciary funds. The larger the government or, the more complex its operations are, the more likely it will report a multitude of funds.

Critics of government financial reporting often say that governments have too many funds. That is true. But government finances are complex. They are spread across many reporting units and serve a wide variety of mandates. So, while fund statements are cumbersome, they are the best available means to ensure fiscal accountability. Below is a quick tour of the fund statements. We begin with a review of the governmental fund statements.


GAAP requires governments to prepare a balance sheet that shows the assets, liabilities, and fund balance in every major governmental fund and the combined assets, liabilities, and fund balance in non-major funds.

Bothell’s governmental fund Balance Sheet is presented here. It shows three discretely presented funds – the General Fund, two special revenue funds (Arterial Street and American Rescue Plan Act), and two capital projects funds (Capital Improvements and Public Safety Capital). All other funds are reported in aggregate in the “Other Governmental Funds.” They include five special revenue funds (Street Fund, Park Reserve, Drug Forfeiture, Fire Impact Fee, and Public Safety Levy), three debt service funds (Public Safety GO Bond, 2013 GO Bond, and LIFT Bond), and a permanent fund (Cemetery Endowment).


Most governments have dozens, if not hundreds, of individual funds. It’s not feasible to report on all of them in the financial statements. To simplify financial reporting, governments draw a distinction between major funds and non-major funds. A fund is classified as a major fund if government officials believe that the fund is particularly important to financial statement users (e.g., the General Fund) or whose total assets plus deferred outflows of resources, liabilities plus deferred inflows of resources, and revenues or expenditures/expenses are at least 10 percent of the relevant fund category (governmental or proprietary) and 5 percent of the corresponding total for all governmental and proprietary funds combined. GAAP requires a set of financial statements for each fund. The major funds are reported in the Basic Financial Statements. Non-major funds are reported in an aggregate format in the Basic Financial Statements and on a disaggregated basis in the Combining Statements, included in the Required Supplementary Section of the Annual Comprehensive Financial Reports (ACFRs).


Special Revenue Funds
Capital Project Funds
General Arterial Street American Rescue Plan Act Capital Improvements Public Safety Capital Other Governmental Funds Total Governmental Funds
Current cash & cash equivalents $12,863,100 $1,797,722 $6,410,842 $13,245,389 $6,917,951 $41,235,005
Investments $5,974,970 $3,000,000 $1,900,000 $28,674,581 $10,824,179 $50,373,731
Receivables (not all allowances)
Taxes $408,610 $169,044 $577,654
Accounts receivable, net $2,450,344 $102,905 $2,553,250
Due from other governmental units 6,586,014 $4,755,964 $175,191 $11,517,170
Total assets $28,283,039 $4,797,722 $6,410,842 $20,004,259 $28,674,581 $18,086,366 $106,256,809
Accounts payable $796,760  –  $1,105  $1,303,051 $3,255,770 $100,599  $5,457,284
Deposits payable  $329,477  –  –  –  – $329,477
Due to other governmental units $110,567 $194,732 $221 $305,520
Payroll payable $1,991,265 $131 $228,198 $2,219,595
Unearned revenue $6,409,606 $6,409,606
Total liabilities $3,228,070 $6,410,842 $1,497,782 $3,255,770 $329,018 $14,721,482
Deferred inflows of resources
Unavailable revenue-property tax, service fees, and impact fees $797,821 $19,533 $136,267 $953,621
Unavailable revenue-advanced grant
Total deferred inflows of resources  $797,821 $19,533 $136,267 $953,621
Fund balances
Restricted $1,008,256 $4,778,189 $18,506,476 $25,418,811 $17,553,388 $67,265,121
Committed $3,516,750 $67,692 $3,584,442
Assigned $1,711,130 $1,711,130
Unassigned $18,021,012 $18,021,012
Total fund balances $24,257,148 $4,778,189 $18,506,476 $25,418,811 $17,621,081 $90,581,705
   $28,283,039 $4,797,722  $6,410,842 $20,004,259  $28,674,581 $18,086,366   $106,256,809

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB

Bothell’s General Fund has $28.3 million in assets. General fund assets far exceed General Fund liabilities ($3.2 million). The city reports deferred inflows related to pre-paid property taxes, special assessments, and grants. While the focus is the General Fund, a significant proportion of resources are restricted and reported outside the General Fund. For the city of Bothell, the General Fund only accounts for 27 percent of the $106.3 million in assets.

The difference between assets and liabilities (net of deferred inflows and outflows) is Fund Balance. According to GAAP, there are five types of fund balance, each corresponding to the strength of restrictions on how fund balance resources can be spent:

  • Non-spendable fund balance is, as the name suggests, not available for spending in the next fiscal period. Governments usually record non-spendable fund balances for items like inventory, legal settlements, small trust funds or endowment funds, or other long-term investments where the corpus of the investment must remain intact. Bothell did not report a non-spendable fund balance in any of its funds.
  • The restricted fund balance, like restricted net assets, can only be spent on purposes prescribed in the government’s constitution, enabling legislation, or some action from an external funder. Bothell, like many other local governments, reports restricted fund balance in the General fund ($1.01 million), special revenue fund ($4.8 million), capital projects funds ($43.9 million), and other non-major funds (including cemetery endowment fund $17.6 million) – for a total restricted fund balance of $67.3 million.
  • Committed fund balance includes amounts that can be used for purposes determined by a governing body’s formal action. State and local legislators will occasionally commit fund balances for capital projects or other one-time spending needs or for rainy-day funds or other budget stabilization funds designed to prevent spending cuts during an economic downturn. The city of Bothell committed $3.5 million in the General Fund and $67,692 in other non-major funds (specifically the Cemetery Endowment Fund). Like most local governments, the City of Bothell does not report a formal rainy day In these instances, the unassigned fund balance becomes an important measure of liquidity (or short-term solvency).
  • Assigned fund balance is restricted by some action other than a governing body commitment or other enforceable restrictions. Usually, this means restrictions that management places on fund balances without the approval of the governing body. The city of Bothell reported $1.7 million in the General Fund as an assigned fund balance. Note 20 in the Notes to the Financial Statements provides additional detail on fund balances. In this instance, the $1.7 million reported in the General Fund is currently assigned to capital projects. Unlike funds reported as committed or restricted, there is greater flexibility in reassigning funds to other uses. Therefore, we consider the assigned fund balance as an “informal” rainy day fund that management, not the governing body, maintains.
  • The unassigned fund balance reports fund balances not subject to any restrictions. At the end of FY 2021, the city of Bothell reported $18 million in unassigned fund balance. Again, the General Fund’s unassigned fund balance is one of the most closely watched indicators of a government’s overall financial position.

Some readers review the governmental fund balance and ask an intuitive question. Do the fund balances in the governmental funds equal the net assets in the governmental activities we see on the government-wide Statement of Net Position? Fund balance and net assets are the residual left when we subtract liabilities from assets. If that is true, the fund balance should be equal to the net position. Except when we look at the two statements, it is quite evident they are not the same. Why? Again, this goes back to the bases of accounting used to prepare financial statements. The government-wide statements are prepared using the accrual basis of accounting with an economic resource measurement focus. In contrast, governmental fund statements are prepared using the modified accrual basis of accounting with a financial resource measurement focus. Given the current financial resources measurement focus, there are no long-term assets or long-term obligations listed in the Balance Sheet. For this, and a variety of other reasons, the fund balance reported in the governmental fund statements differs substantively from the net position reported in the Statement of Net Position.

As noted earlier, the city of Bothell reports nine non-major funds, including (a) Street, (b) Park Cumulative Reserve, (c) Drug Forfeiture, (d) Fire Impact Fee, and (e) Public Safety Levy, (f) the 2013 General Obligation Bond, (g) the 2014 Local Infrastructure Financing Tool (LIFT) Bond, (j) Public Safety GO Bond and (k) the Cemetery Endowment Fund. Detailed information on every fund can be found in “Combining Financial Statements.” The combining financial statements supplement the basic financial statements. The basic financial statements for governmental and proprietary funds have columns for each of the major funds and a single column in which all the nonmajor funds are aggregated. The combining statements provide the details of the nonmajor funds with one column for each.

Special Revenue Funds
Permanent Fund
Street Park Cumulative Balance Drug Forfeitures Fire Impact Fees Public Safety Levy Total Special Revenue Funds Cemetery Endowment 2013 GO Bond Lift GO Bond Public Safety GO Bond Total Debt Service Funds Total Other Governmental Funds
Current cash & cash equivalents $1,809,117 $1,913,245 $163,490 $459,390 $2,488,696 $6,833,938 $84,013 $6,917,951
Investments $3,050,000 $4,000,000 $3,774,179 $10,824,179 $10,824,179
Receivables (net of allowance)
Taxes receivable $72,831 $74,845 $147,676 $21,368 $21,368 $169,044
Accounts receivable
Due from other governmental units $144,147 $31,044 $175,191 $175,191
Total assets $5,076,095 $5,913,245 $194,535 $459,390 $6,337,720 $17,980,985 $84,013 $21,368 $21,368 $18,086,366
Accounts payable $49,015 $40,366 $9,226 $1,992 $100,599 $100,599
Due to other governmental units $221 $221 $221
Payroll payable $65,927 $162,271 $228,198 $228,198
Unearned revenue
Total liabilities $115,163 $40,366 $9,226 $164,263 $329,018 $329,018
Unavailable revenue $58,584 $60,290 $118,873 $17,394 $17,394 $136,267
Total deferred inflows of resources $58,584 $60,290 $118,873 $17,394 $17,394 $136,267
Restricted $4,902,348 $5,872,879 $194,535 $450,164 $6,113,168 $17,533,093 $16,321 $3,974 $3,974 $17,553,388
Committed $67,692 $67,692
Total fund balances $4,902,348 $5,872,879 $194,535 $450,164 $6,113,168 $17,533,093 $84,013 $3,974 $3,974 $17,621,081
$5,076,095 $5,913,245 $194,535 $459,390 $6,337,720 $17,980,985 $84,013 $21,368 $21,368 $18,086,366

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB

The “Combining Balance Sheet” reports assets, liabilities, and fund balances in each of these funds. Total assets reported here ($18.1 million) are also reported, in a single column, in the Balance Sheet included in the Basic Financial Statements (see second-to-last column titled “Other Governmental Funds”). Again, the main difference here is that we now know how these assets are reported in each non-major fund. For example, we now know that the Public Safety Levy fund is the largest non-major fund ($6.3 million in assets). We also know that of the $5.1 million reported in the Street Fund, $1.8 million was in cash and cash equivalents, $3.1 million was in investments, and the remainder was in receivables. So why is reporting information in the combining statements important? If you are a resident of Bothell, you want to know if dedicated taxes for streets, parks, or public safety are reported in the appropriate special revenue fund – or that dedicated tax revenues are appropriately transferred from the General Fund to the special revenue fund. The Combining Financial Statements provide you with that additional information.

That said, there is not a lot of activity reported in the non-major funds. For that reason, the combining financial statements are relegated to the Required Supplementary Section of the ACFRs. The city reports fund balances in every special revenue fund and the sole permanent fund (i.e., the Cemetery Endowment fund). Two of the three debt service funds do not report fund balances. That is not unusual.


The Statement of Revenues, Expenditures, and Changes in Fund Balance is an income statement prepared on a modified accrual basis in the governmental fund statements. It lists the revenues, expenditures, and the change in fund balances. In this case, changes in fund balance are akin to changes in net assets or changes in net position.

Bothell’s Statement of Revenues, Expenditures, and Changes in Fund Balances shows that its two largest overall revenue sources are taxes ($40.5 million in the General Fund, $62 million total). Other sources of revenue include licenses and permits ($4 million in the General Fund, $4.6 million total), intergovernmental revenue ($2.8 million in the General Fund, $14.9 million total), and charges for services ($12.7 million in the General Fund, $17.8 million total).

An expenditure is roughly equivalent to an expense, albeit on the modified accrual basis of accounting (again, more on this in Chapter 4). Nearly two-thirds of the city’s total governmental funds expenditures are in the General Fund ($55.4 million). More than half of Bothell’s General Fund expenditures are for public safety ($29.4 million). This is typical of mid- and large-sized suburban cities. The remainder of governmental fund expenditures go to administrative functions of the city ($14.2 million), transportation ($12.2 million), economic environment ($5.9 million), capital outlays ($18 million), and debt service ($4.3 million). In general, non-capital expenditures in the General Fund are a good proxy for a government’s “operating costs.” Most of its salaries, benefits, and operational spending will appear as General Fund expenditures. By contrast, most of the revenues and expenditures in the special revenue and debt service funds will be related to capital spending and debt repayments, neither of which are considered day-to-day operations costs.

At the bottom of this statement, we also see “other financing sources.” These are inflows and outflows of resources that affect fund balance, which are neither revenues nor expenditures. They frequently include loan or bond proceeds, proceeds from the sale of assets, and insurance recoveries, to name a few.

Special Revenue Funds
Capital Projects Fund
General Arterial Street American Rescue Plan Act Capital Improvements Public Safety Capital Other Governmental Funds Total Governmental Funds
Taxes $40,450,611 $8,623,599 $12,920,156 $61,994,366
Licenses and permits $3,969,487 $541,158 $116,047 $4,626,692
Intergovernmental revenues $2,842,205 $214,759 $10,863,104 $1,026,162 $14,946,230
Charges for services $12,663,650 $3,501,226 1,626,978 $17,791,854
Fines and forfeitures $197,922 $88,034 $285,956
Interest earnings $86,555 $22,407 $108,963
Contributions $11,363 $66,542 $77,906
Other revenue $787,452 $83,046 $1,247 $871,744
Total revenue $61,009,245 $3,501,226 $214,759 $20,177,450 $22,407 $15,778,624 $100,703,711
General government $13,037,933 $207,887  – $925,885 $14,171,705
Security of persons and property  $29,379,058  –  –  –  –  $1,556,708  $30,935,766
Transportation  $5,271,282  –  –  $4,370,189  –  $2,522,019  $12,163,491
Physical environment  $22,322  –  $6,871  –  –  $29,193
Economic environment $5,218,407 $681,344 $5,899,751
Culture and recreation $2,074,024 $2,074,024
Other expenditures $300 $300 $300 $900
Debt service
Debt service – principal $1,976,759 $2,000,000 $3,976,759
Debt service – interest $11,012 $1,820,835 $2,307,700 $4,139,547
Issuance costs $105,653 $105,653
Capital outlay $365,048 $9,890,413 $7,464,886 $291,819 $18,012,166
Total expenditures $55,379,086 $18,739,840 $7,570,839 $9,604,432 $91,508,955
Excess (deficiency) of revenue over expenditures $5,630,160 $3,501,226 $214,759 $1,437,610 ($7,548,431) $6,174,192 $9,194,756
Sales of capital assets $4,737 $13,465,000 $13,469,737
Proceeds from public safety bonds $8,135,000 $8,15,000
Proceeds from public safety bond premium $1,859,659 $1,859,659
Transfer in $6,750,194 $5,363,973 $1,691,963 $13,806,130
Transfer out ($2,119,173) ($1,959,609) ($8,442,157) ($1,996,100) ($14,517,039)
Total other financing sources (uses) $4,635,758 ($1,959,609) $10,386,816 $9,994,659 ($304,137) $22,753,487
Net change in fund balances $10,265,917   $1,541,617 –  $11,824,426  $2,446,227   $5,870,055 $31,948,243 
Fund balance – beginning  $13,991,231  $3,236,572  –  $6,682,050  $22,972,584  $11,751,025  $58,633,462
   $24,257,148  $4,778,189  –  $18,506,476  $25,418,811  $17,621,081 $90,581,705 

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB

The last two lines of other financing sources are an important and sometimes controversial part of governmental accounting: inter-fund transfers. Transfers in are movements of resources into a fund from some other fund. Transfers out are movements of resources out of a fund into some other fund. For example, in 2021, the city transferred to the General Fund $6.8 million. Transfers from the General Fund ($2.1 million) were distributed to the Capital Improvement Fund and Internal Service Funds. How are we able to know this? Governments frequently chart the transfers to and from funds in the notes to the financial statements. Look for a note on “interfund transfers.”

Critics say governments use inter-fund transfers to perpetuate a financial “shell game.” By opportunistically transferring money in and out of funds (frequently known as fund sweeps) at just the right moment, the government can obscure its actual financial position. How and when transfers can and should happen are important parts of financial strategy and policy.


In September 2016, the former mayor and finance director of the City of Miami, FL, was convicted in federal court of defrauding investors. Their crime, according to prosecutors from the Securities and Exchange Commission (SEC), was that they improperly transferred money that had been committed to debt service in other funds into the City’s General Fund. City officials argued those transfers were common and were necessary to bolster the City’s financial position just before the credit rating agencies updated the city’s rating.
SEC officials and the jury disagreed. In their view, those transfers misled investors into thinking the City was financially stronger than it really was. Shortly after the verdict, City officials began negotiating a financial settlement with the SEC.
See SEC compliant: https://www.sec.gov/litigation/complaints/2013/comp-pr2013-130.pdf

As we noted earlier, detailed information on every non-major fund can be found in the Combining Statements of Revenues, Expenses, and Changes in Fund Balance. Total Revenues reported in the “Other Governmental Funds” ($15.8 million) previously are now reported in the combining statement for every non-major fund. We see that much of the revenue is reported in the Street fund ($6.1 million), the Park Cumulative Reserve fund ($1.6 million), and the Public Safety GO ($1.6 million). There were no revenues reported in the permanent fund and transfers to the 2013 GO Bond and LIFT GO Bond fund were used to meet principal and interest payments on outstanding bonds. This is not unusual. General obligation bonds would be repaid with tax revenues. If there are no dedicated taxes, revenues would be to a bond fund to meet debt service obligations. This is a policy decision.

Special Revenue Funds
Permanent Fund
Street Park Cumulative Balance Drug Forfeitures Fire Impact Fees Public Safety Levy Total Special Revenue Funds Cemetery Endowment 2013 GO Bond Lift GO Bond Public Safety GO Bond Total Debt Service Funds Total Other Governmental Funds
Taxes $5,002,944 $163,463 $5,137,364 $10,303,771 $1,000,000 $1,616,386 $2,616,386 $12,920,156
Licenses and permits $116,047 $116,047 $116,047
Intergovernmental revenue $999,283 $26,879 $1,026,162 $1,026,162
Charges for services $24,152 $1,471,323 $131,503 $1,626,978 $1,626,978
Fine and forfeitures $88,034 $88,034 $88,034
Other revenues $1,247 $1,247 $1,247
Total revenues $6,143,673 $1,634,786 $88,034 $131,503 $13,162,239 $1,000,000 $1,616,386 $2,616,386 $15,778,624
General government $925,885 $925,885 $925,885
Security $3,383 $1,553,325 $1,556,708 $1,556,708
Transportation $2,522,019 $2,522,019 $2,522,019
Physical environment
Capital outlay $291,819 $291,819 $291,819
Other expenditures $300 $300 $300
Debt service
Principal retirement $425,000 $795,000 $780,000 $2,000,000 $2,000,000
Interest $271,013 $1,200,650 $836,038 $2,307,700 $2,307,700
Total expenditures $2,522,019 $3,383 $2,771,029 $5,296,432 $696,313 $1,995,650 $1,616,038 $4,308,000 $9,604,432
Excess of revenues over (under expenditures) $3,621,654 $1,634,786 $84,651 $131,503 $2,393,214 $7,865,807 ($696,313) ($995,650) $348 ($1,691,615) ($304,137)
Transfers in $696,313 $995,650 $1,691,963 $1,691,963
Transfer out ($1,942,944) ($25,000) ($28,156) ($1,996,100) ($1996,100)
Total other financing sources (uses) ($1,942,944) ($25,000) ($28,156) ($1,996,100) $696,313 $995,650 $1,691,963 ($304,137)
Net change in fund balances $1,678,710 $1,609,786 $4,651 $131,503 $2,365,058 $5,869,708 $348 $348 $5,870,055
Fund balance -beginning $3,223,639 $4,263,094 $109,884 $318,661 $3,748,109 $11,663,386 $84,013 $3,626 $3,626 $11,751,025
  $4,902,348 $5,872,879 $194,535 $450,164 $6,113,168 $17,533,093 $84,013 $3,974 $3,974 $17,621,081

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB


Governments account for their business-type activities using the accrual basis of accounting. This is the same basis of accounting used to prepare government-wide statements. The proprietary fund statements disaggregate information reported under business-type activities by fund type. We rewrite the fundamental equation of accounting as follows

Assets + Deferred Outflows = Liabilities + Deferred Inflows + Net Position


Governments report proprietary fund assets, liabilities, and net position in a Statement of Net Position. Proprietary fund statements draw a distinction between major and non-major proprietary funds. Bothell is unique in that it did not have any non-major proprietary funds. There are only three funds – Water, Sewer, and Storm and Surface Water.

Total assets in Water ($25.9 million), Sewer ($23.5 million), and Storm and Surface Water ($42.2 million) add up to the total assets reported under business-type activities ($91.5 million). Again, the difference between the government-wide statement of Net Position and the proprietary fund Statement of Net Position is the detailed reporting of assets, liabilities, revenues, and expenses by fund type – Water, Sewer, and Storm and Surface Water.

The proprietary fund Statement of Net Position reports current assets ($26.3 million) separately from non-current assets ($65.2 million). Governments are not required to report current assets separately from their non-current assets in the government-wide statements, but that breakdown is required in the proprietary fund statements.

Like most local governments, revenue bonds make up a large proportion of liabilities ($13.5 million). A large proportion of the city’s proprietary fund liabilities are in the Storm and Street Water fund ($10.9 million).

Like the government-wide Statement of Net Position, the proprietary fund Statement of Net Position classifies the position as either Net Investment in Capital Assets, Restricted Net Position, or Unrestricted Net Position.

  • Net Investment in Capital Assets in the historical cost of capital improvements – net of depreciation – and debt associated with the acquisition, construction, or improvement of capital In the Water Fund, net investment in capital assets is equal to $16,634,885 – i.e., Capital Assets not being depreciated plus capital assets being depreciated minus depreciation ($19,670,033) minus the current portion of revenue bonds payable, net ($183,345) minus non-current revenue bonds payable ($2,851,803).
  • The restricted net position represents assets restricted by a third party or law. Governments are frequently required to establish restricted reserve funds following a revenue bond issue to ensure payments occur on time and in full. Revenue bond reserve funds are often the lesser of (a) maximum annual debt service, (b) 125 percent of average annual debt service, or (c) 10 percent of original bond proceeds.
  • The remainder is reported as the unrestricted net position. Each business-type activity reports a positive unrestricted net position.
Business-Type Activities, Enterprise Funds
Governmental Activities
Water Sewer Storm & Surface Water Total Internal Service Funds
Current assets
Cash and cash equivalents $303,342 $744,901 $2,049,875 $3,098,118 $2,390,973
Investments $4,190,215 $6,307,503 $8,464,320 $18,962,038 $2,300,000
Accounts receivable $859,474 $1,817,087 $2,676,561 $53,396
Due from other governments $357 $56,256 $211,575 $268,188 $5,522
Reserved assets
Deposit held in trust $277,395
Investment-revenue bond reserve $109,785 $292,497 $914,086 $1,316,369
Total current assets $5,463,173 $9,218,244 $11,639,857 $26,321,274 $5,027,286
Non-current assets
Net pension assets $724,367 $547,655 $1,303,964 $2,575,986 $38,766
Capital assets not being depreciated
Land $122,175 $163,126 $285,302
Right of way 1,935,868 $1,935,868
Construction in progress $405,339 $997,494 $1,757,076 $3,159,909
Capital assets being depreciated
Intangible assets $141,538 $122,978 $146,663 $411,179
Buildings $2,729,301 $3,513,086 $2,304,125 $8,546,512 $35,285
Improvements other than buildings $29,514,840 $17,760,228 $36,850,875 $84,125,944 $1,042,450
Equipment $59,048 $1,806,274 $275,951 $2,141,273 $1,829,336
Vehicles $30,457 $30,457 $250,920 $311,834 9,562,936
Less accumulated depreciation ($13,332,666) ($10,711,077) ($14,284,192) ($38,327,935) ($8,960,868)
Total non-current assets $20,394,400 $14,230,221 $30,541,250 $65,165,871 $4,047,905
Total assets $25,857,573 $23,448,464 $42,181,107 $91,487,144 $9,075,191
Deferred outflows-pension $80,511 $64,930 $152,126 $297,567 $55,324
Total deferred outflows of resources $80,511 $64,930 $152,126 $297,567 $55,324
Current liabilities
Accounts payable $355,435 $28,875 $174,040 $558,349 $59,031
Payroll payable $66,558 $51,260 $119,130 $236,948 $43,504
Compensated absences $87,001 $86,807 $111,987 $285,795 $42,112
Due to other governments $1,166 $593 $1,759 $39,488
Interest payable $144,831
Current portion of loans payable $45,516 $45,516
Current portion of revenue bonds payable, net $183,345 $86,047 $608,890 $878,281
Total current liabilites $693,504 $252,988 $1,060,157 $2,006,648 $328,966
Non-current liabilities
Loans payable $56,250 $455,497 $511,747
Revenue bonds payable, net $2,851,803 $1,276,047 $9,400,707 $13,528,557
Unearned revenue $277,395
Total non-current liabilities  $2,851,803 $1,332,297 $9,856,204 $14,040,304 $277,395
Total liabilities $3,545,307 $1,585,285 $10,916,361 $16,046,952 $606,361
Deferred inflows – advance grant $12,909 $12,909
Deferred inflow – pension $678,978 $515,295 $1,223,171 $2,417,444 $502,186
Total deferred inflows of resources $678,978 $515,295 $$1,236,080 $2,430,353 $502,186
Net investment in capital assets $16,634,885 $12,264,222 $18,726,676 $47,635,783 $3,509,139
Restricted for pension assets $125,900 $97,290 $220,010 $443,200 $91,904
Restricted for debt service $109,785 292,497 $914,086 $1,316,369
Unrestricted $4,843,229 $8,758,806 $10,320,020 $23,922,054 $4,420,925
Total net position $21,713,799 $21,412,814 $30,180,793 $73,307,406 $8,021,968

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB

Internal service funds are reported in the proprietary fund statements. They account for programs in government that serve other parts of the government. The city of Bothell has three internal service funds – Equipment Rental (Fleet), Self-Insurance, and Asset Replacement. Internal service funds are designed to be self-supporting. They bill the receiving department at rates intended to cover the costs of goods or services provided. Keep in mind that these funds are not reported in the government-wide statements, as internal service accounts cancel out once we aggregate governmental activities with proprietary activities.


The proprietary fund Statement of Revenues, Expenses, and Changes in Fund Net Position presents a summary of revenues, expenses, and changes in net position in the proprietary fund statements by fund type. A couple of features here merit additional discussion.

First, you will notice that Proprietary Fund Statements draw a distinction between operating revenues and non-operating revenues (expenses). Charges for services ($21.9 million) are reported under operating revenues. Note that the amount reported in the Statement of Revenues, Expenses, and Changes in Net Position is the same as that reported under business-type activities as Charges for Services.

Business-type activities report a modest amount in operating grants and contributions ($7,763) and capital grants and contributions ($1.8 million). Operating grants and contributions are not reported as operating revenues; rather, they are reported as non-operating revenues. The capital grants and contributions are also reported as non-operating revenues, just below transfers out. Reporting operating and capital grants and contributions as non-operating revenues reflects the non-recurring nature of revenues. The capital grants are reported separately from operating grants to reflect the fact that these revenues are not part of general operations.

Business-Type Activities, Enterprise Funds
Governmental Activities
Water Sewer Storm & Surface Water Total Internal Service Funds
Charges for services $6,339,397 $8,788,494 $6,863,366 $21,991,257 $4,022,162
Other operating revenue $3,011 $62,564 $44,855 $110,430
Total operating revenue $6,342,408 $8,851,058 $6,908,221 $22,101,687 $4,022,162
Administrative and general $897,152 $1,067,502 $2,003,189 $3,967,843 $2,788,021
Purchased water $1,734,839 $1,734,839
Metro service $4,480,487 $4,480,487
Maintenance and operations $984,712 $689,838 $1,593,614 $3,268,165 $381,957
Customer accounts $200,068 $199,591 $399,659
Taxes $825,860 $633,502 $476,404 $1,935,766
Depreciation $881,887 $632,655 $1,333,495 $2,848,037 $962,396
Total operating expenses $5,534,519 $7,703,575 $5,406,702 $18,634,796 $4,132,374
Operating income (loss) $817,889 $1,147,483 $1,501,519 $3,466,891 ($110,213)
Investment income $6,428 $6,428 $1,677,027
Intergovernmental revenue $241 $198 $7,324 $7,763 $3,906
Miscellaneous revenue $18,762 $251,247 $270,009
Proceeds from sale of capital assets including insurance recoveries $157,386
Gain (loss) on disposition of capital assets ($264,102)
Revenue bonds interest ($98,686) ($44,310) ($326,807) ($469,803) ($1,670,280)
Total non-operating revenue (expenses) ($79,683) ($44,112) ($61,808) ($185,603) ($96,064)
$738,206 $1,103,371 $1,439,712 $3,281,288 ($206,276)
Transfers in $2,349,660
Transfers out ($78,134) ($73,909) ($256,222) ($408,265) ($1,230,487)
Capital contributions $382,712 $289,043 $1,094,538 $1,766,293
Change in net position $1,042,784 $1,318,505 $2,278,028 $4,639,317 $912,897
Net position -beginning $20,671,015 $20,094,310 $27,902,765 $68,668,090 $7,109,071
Net position – ending $21,713,799 $21,412,814 $30,180,793 $73,307,406 $8,021,968

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB


We’ve covered governmental, proprietary, and internal service funds. The final type of fund you’ll see on a government’s financial statements is fiduciary funds. Fiduciary funds account for resources held for the benefit of parties outside of the reporting government. Fiduciary funds are not reported in the government-wide financial statements because the resources of those funds are not available to support the government’s own programs.

Most fiduciary funds relate to retiree benefits (i.e., pension and OPEB). Different plans are managed in quite different ways. Some are managed at the state level, and beneficiaries are not only state employees but also employees of local governments that participate in state-sponsored or state-administered plans. Some governments are “self-funded,” meaning they manage a plan whose members come only from their government. In Washington, most public employee pension and OPEB plans are managed by the state. For that reason, the fiduciary fund statements for the State of Washington are extensive, as they account for all retirement plans administered and managed by the state.

The City of Bothell does not report any assets held on behalf of its employees. In other words, retirement benefits for current and former employees of the city of Bothell are administered by the state. The city does not report any employee retirement benefit funds in its fiduciary funds. Rather the city reports two trust funds a Private-Purpose Trust Fund and a Custodial Fund. The Private Purpose Trust funds include proceeds held on behalf of beneficiaries in the Court Bail Bond Trust and Court Restitution Trust. The Custodial Fund reports court collection fees on behalf of King County and the state of Washington.

Private-Purpose Trust Funds Custodial Funds Total
Cash and cash equivalents $38,758 $32,255 $71,013
Total assets $38,758 $32,255 $71,013
Total deferred outflows of resources
Accounts payable $32,143 $32,143
Total liabilities $32,143 $32,143
Total deferred inflows of resources
Restricted for
Individuals, organizations, and other governments $38,758 $112 $38,870
 Total net position  $38,758 $112 $38,870

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB

Governments also produce a Statement of Changes in Fiduciary Net Position. This statement is similar to an income statement. Instead of revenues and expenditures, it identifies additions and deductions to the fiduciary funds. Additions reflect the increase in assets – deductions account for the decrease in assets. For the city of Bothell, additions in the fiduciary fund statements included payments to the Court Bail Bond Trust, the Court Restitution Trust, and fees collected on behalf of King County and the state of Washington. Deductions reported payments in each of these accounts.

Private-Purpose Trust Funds Custodial Funds Total
Court bail bond/restitution trust $82,005 $82,005
Fees collections for other governments $186,271 $186,271
Total additions $82,005 $186,271 $268,276
Payments of court bail bond/restitutions $84,262 $84,262
Payments of fee to other government $186,918 $186,918
Total deductions $84,262 $186,918 $271,180
Net increase (decrease) in fiduciary net position ($2,258) ($647) ($2,905)
Net position – beginning $41,015 $759 $41,774
Net position – ending $38,758 $112 $38,870

Download City of Bothell’s 2021 Annual Comprehensive Financial Report: https://bit.ly/3sskqZB


The federal government does, in fact, prepare a set of audited financial statements known as the Financial Report of the United States Government. A division of the U.S. Treasury known as the Bureau of the Fiscal Service prepares this report according to a set of accounting principles developed by the Federal Accounting Standards Advisory Board (FASAB). Those principles are similar to modified accrual accounting, focusing on financial resources and fiscal accountability. They also incorporate some recognition concepts that speak to the unique nature of federal appropriations and budget authority. The Government Accountability Office (GAO) then audits those statements according to those standards.
The federal government has never received an audit opinion on these financial statements. GAO has yet to issue an opinion due to several material weaknesses in internal controls, especially at the Department of Defense (DOD). That said, the federal government has substantially improved its financial reporting processes. Today almost all of the 24 major cabinet agencies have received an unqualified audit opinion, and the DOD has convened a high-level task force to address its internal control shortcomings.


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Financial Strategy for Public Managers Copyright © 2023 by Sharon Kioko and Justin Marlowe is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.