Proprietary funds are a distinct category of funds used by governmental entities to account for activities that are similar to those found in the private sector. These funds are used to report on activities where the costs of providing goods or services are recovered primarily through user charges.
Types of Proprietary Funds
Enterprise Funds
Enterprise funds are one type of proprietary fund. They are used to account for any activity for which a fee is charged to external users for goods or services. Common examples include public utilities (e.g., water, sewer), public transportation systems, and public hospitals.
Internal Service Funds
Internal service funds, another subtype of proprietary funds, account for the financing of goods or services provided by one department or agency to other departments or agencies within the same government, on a cost-reimbursement basis. Examples include centralized information technology services, motor pools, and insurance services.
Characteristics of Proprietary Funds
- Accrual Basis of Accounting: Proprietary funds use the accrual basis of accounting, where revenues and expenses are recognized when they are earned or incurred, respectively.
- Full Cost Accounting: These funds aim to recover the full cost of operations, including depreciation and indirect costs, typically through user fees.
- Separate Financial Statements: Proprietary funds require separate financial statements, including a statement of net position, a statement of revenues, expenses, and changes in fund net position, and a statement of cash flows.
Examples
- Water and Sewer Operations: Government-owned water and sewer utilities are typically accounted for in enterprise funds, where user charges fund the operation and maintenance of these services.
- Public Transit Agencies: Local governments might use enterprise funds to manage buses, trains, and other forms of public transportation, ensuring efficiency through user fares.
- Internal IT Services: A city government may use an internal service fund to manage its information technology services, allocating the costs to various departments based on their usage.
Historical Context
The use of proprietary funds has grown alongside the expansion of government services that closely resemble business operations. This trend reflects a broader movement towards efficiency and self-sustainability within public sector activities, making governmental financial practices more comparable to those of private enterprise.
Applicability
Proprietary funds are essential for managing and reporting the financial performance of government activities that are expected to operate with a business-like approach. They provide clarity, accountability, and transparency in how these activities are funded and managed, highlighting their importance in public finance.
Comparisons
Proprietary Funds vs. Governmental Funds
- Proprietary Funds: Designed for activities like business operations, using accrual accounting.
- Governmental Funds: Used for regular government operations like public safety and education, typically using modified accrual accounting.
Related Terms
- Fund Accounting: A system used by nonprofit organizations and governments to separate resources according to purpose and restrictions.
- Accrual Accounting: An accounting method where revenues and expenses are recorded when they are earned or incurred, not when cash is exchanged.
FAQs
Q: What is the main purpose of proprietary funds? A: To manage governmental activities that operate similarly to private sector businesses, ensuring that user fees cover the full costs of providing services.
Q: How do enterprise funds differ from internal service funds? A: Enterprise funds serve external customers, while internal service funds cater to internal government departments or agencies.
Q: Why do proprietary funds use accrual accounting? A: Accrual accounting provides a more accurate financial picture by recognizing revenues and expenses when they are earned or incurred.
References
- Governmental Accounting Standards Board (GASB). (n.d.).
GASB Concepts Statement No. 4: Elements of Financial Statements. - United States Government Accountability Office (GAO). (2022).
Understanding Fund Accounting.
Summary
Proprietary funds are critical in public finance for managing government activities that closely mirror private business operations. They ensure comprehensive cost recovery through the use of detailed financial statements and accrual accounting. By maintaining separate funds for specific purposes like public utilities and internal services, governmental entities can enhance transparency, accountability, and operational efficiency.
