HomeMy WebLinkAbout- - GFOA Best Practice Attachment 1 - 10/18/2011BEST PRACTICE
Appropriate Level of Unrestricted Fund Balance in the General Fund (2002 and 2009) (BUDGET
and CAAFR)
Background. Accountants employ the term fund balance to describe the net assets of governmental funds
calculated in accordance with generally accepted accounting principles (GAAP). Budget professionals commonly
use this same term to describe the net assets of governmental funds calculated on a government's budgetary
basis.' In both cases, fund balance is intended to serve as a measure of the financial resources available
in a governmental fund.
Accountants distinguish up to five separate categories of fund balance, based on the extent to which the
government is bound to honor constraints on the specific purposes for which amounts can be spent: nonspendable
fund balance, restricted fund balance, committed fund balance, assigned fund balance, and unassigned fund
balance.2 The total of the last three categories, which include only resources without a constraint on spending or
for which the constraint on spending is imposed by the government itself, is termed unrestricted fund balance.
It is essential that governments maintain adequate levels of fund balance to mitigate current and future risks (e.g.,
revenue shortfalls and unanticipated expenditures) and to ensure stable tax rates. Fund balance levels are a crucial
consideration, too, in long-term financial planning.
In most cases, discussions of fund balance will properly focus on a government's general fund. Nonetheless,
financial resources available in other funds should also be considered in assessing the adequacy of unrestricted
fund balance (i.e., the total of the amounts reported as committed, assigned, and unassigned fund balance) in the
general fund.
Credit rating agencies monitor levels of fund balance and unrestricted fund balance in a government's general
fund to evaluate a government's continued creditworthiness. Likewise, laws and regulations often govern
appropriate levels of fund balance and unrestricted fund balance for state and local governments.
Those interested primarily in a government's creditworthiness or economic condition (e.g., rating agencies) are
likely to favor increased levels of fund balance. Opposing pressures often come from unions, taxpayers and
citizens' groups, which may view high levels of fund balance as "excessive."
Recommendation. The Government Finance Officers Association (GFOA) recommends that governments
establish a formal policy on the level of unrestricted fund balance that should be maintained in the general fund.3
Such a guideline should be set by the appropriate policy body and should provide both a temporal framework and
' For the sake of clarity, this recommended practice uses the terms GAAP fund balance and budgetary fund balance to
distinguish these two different uses of the same term.
2 These categories are set forth in Governmental Accounting Standards Board (GASB) Statement No. 54, Fund Balance
Reporting and Governmental Fund Type Definitions, which must be implemented for financial statements for periods ended
June 30, 2011 and later.
3 Sometimes restricted fund balance includes resources available to finance items that typically would require the use of
unrestricted fund balance (e.g., a contingency reserve). In that case, such amounts should be included as part of unrestricted
fund balance for purposes of analysis.
specific plans for increasing or decreasing the level of unrestricted fund balance, if it is inconsistent with that
Policy. 4
The adequacy of unrestricted fund balance in the general fund should be assessed based upon a government's own
specific circumstances. Nevertheless, GFOA recommends, at a minimum, that general-purpose governments,
regardless of size, maintain unrestricted fund balance in their general fund of no less than two months of regular
general fund operating revenues or regular general fund operating expenditures.s The choice of revenues or
expenditures as a basis of comparison may be dictated by what is more predictable in a government's particular
circumstances.6 Furthermore, a government's particular situation often may require a level of unrestricted fund
balance in the general fund significantly in excess of this recommended minimum level. In any case, such
measures should be applied within the context of long-term forecasting, thereby avoiding the risk of placing too
much emphasis upon the level of unrestricted fund balance in the general fund at any one time.
In establishing a policy governing the level of unrestricted fund balance in the general fund, a government should
consider a variety of factors, including:
• The predictability of its revenues and the volatility of its expenditures (i.e., higher levels of unrestricted
Raid balance may be needed if significant revenue sources are subject to unpredictable fluctuations or if
operating expenditures are highly volatile);
• Its perceived exposure to significant one-time outlays (e.g., disasters, immediate capital needs, state
budget cuts);
• The potential drain upon general fund resources from other funds as well as the availability of resources
in other funds (i.e., deficits in other funds may require that a higher level of unrestricted fund balance be
maintained in the general fund, just as, the availability of resources in other funds may reduce the amount
of unrestricted fund balance needed in the general fund);'
• Liquidity (i.e., a disparity between when financial resources actually become available to make payments
and the average maturity of related liabilities may require that a higher level of resources be maintained);
and
• Commitments and assignments (i.e., governments may wish to maintain higher levels of unrestricted fund
balance to compensate for any portion of unrestricted fund balance already committed or assigned by the
government for a specific purpose).
Furthermore, governments may deem it appropriate to exclude from consideration resources that have been
committed or assigned to some other purpose and focus on unassigned fund balance rather than on unrestricted
fund balance.
Naturally, any policy addressing desirable levels of unrestricted fund balance in the general fund should be in
conformity with all applicable legal and regulatory constraints. In this case in particular, it is essential that
differences between GAAP fund balance and budgetary fund balance be fully appreciated by all interested parties.
Approved by the GFOA's Executive Board, October, 2009.
4 See Recommended Practice 4.1 of the National Advisory Council on State and Local Budgeting governments on the need to
"maintain a prudent level of financial resources to protect against reducing service levels or raising taxes and fees because of
temporary revenue shortfalls or unpredicted one-time expenditures" (Recommended Practice 4.1).
5 In practice, a level of unrestricted fund balance significantly lower than the recommended minimum may be appropriate for
states and America's largest governments (e.g., cities, counties, and school districts) because they often are in a better
position to predict contingencies (for the same reason that an insurance company can more readily predict the number of
accidents for a pool of 500,000 drivers than for a pool of fifty), and because their revenues and expenditures often are more
diversified and thus potentially less subject to volatility.
6 In either case, unusual items that would distort trends (e.g., one-time revenues and expenditures) should be excluded,
whereas recurring transfers should be included. Once the decision has been made to compare unrestricted fund balance to
either revenues or expenditures, that decision should be followed consistently from period to period.
However, except as discussed in footnote 4, not to a level below the recommended minimum.
2