 Hello, and welcome to the session in which we would look at the difference between government and not-for-profit entities to businesses. So this is a government and not-for-profit course. So the first thing we want to look at is the differences. What are the main differences? Because having a theoretical background about the differences will help you understand why we do things certain ways. So when we get to the accountings aspect of the scores, understanding the background will help you much, much more with the journal entries with preparing financial reports. Why do we do things in a certain way? So the first difference we're going to look at, the first difference between the two, is the mission of government and not-for-profit, which is GNP, government and not-for-profit, government and not-for-profit versus a business. The first one is mission. The mission of government and not-for-profit is to do what? Is to provide services for the betterment of the society. So for government and not-for-profit is to provide services. What type of services? Well, maybe help the poor, for example, for not-for-profit, for government, for example, provide public safety, provide services that's going to protect the public in general. The business, they have a different mission. The business is to earn a profit, to owners. And it's important to know that business have owners. Of course, they do. Someone owns a business. So the business, they want to provide the owners with profit. They work to provide owners with profit. Government and not-for-profit to provide services for the betterment to make the society better. Okay, so that's one of the main differences. Now, when we say the betterment of the society is what? Really, there are, who are the betterment of the society? The people that live under the jurisdiction of that government. So basically, technically, the voters, those are the people that live there. Another important distinction between government and not-for-profit is there is no direct and proportional relationship between resources provided and the benefit and the benefits received. If you really think of a business, if you really think of a business, the way business function, okay, the way business function, every time they buy an asset, they do what's called cost-benefit analysis. Maybe they would look at the future cash flow from that asset to make sure that this asset would recover. It is investment. So when you buy an asset, that's what you do. You want to make sure the asset is providing benefit. Well, under government and not-for-profit, there is no direct and proportional relationship. Between those two, why? Because think about a road. If you think about a road, a road is an asset. Technically, a road is an asset. And what they do is when the government open a road or maintain a road, they don't expect to receive benefit. So the asset that they invested in, it doesn't mean it's going to benefit them proportionally. It may benefit, it may not benefit. Maybe the road is costing the government money to maintain from year to year. But the government doesn't look at the relationship. They don't do an asset, a cost-benefit analysis or a future cash flow analysis. Businesses, they do. So here, there is no direct relationship in business before they buy an asset. They want to make sure it's worth it. The third difference is the absence of transferable ownership right. Of course, here we have technically no owners, no true owners. Who are the owners of the government and not-for-profit? Especially the government are the voters. Okay, the voters are the true owners of the government. In a business, we have stockholders. And guess what? As a stockholder, you do have ownership rights. Voters, you don't have ownership rights. Tomorrow, you might leave the borough or the city or the locality in which you live. So you don't really own anything, but you are technically the owner in a sense that you can vote to the people who are in charge. Because in a business, the stockholders vote to the people who are in charge. In a government, the people votes to the people who's going to be in charge. Collective ownership by constituent. Constituent, another word for constituent is voters. So that's an again, we've been talking about this. So who really owned the government in theory, the voters in theory, the voters because they could vote whoever they want to to control the government to run the government. Therefore, the government is run on behalf of the constituent, constituent, who are the voters. In a business, guess what? The stockholders are the owners. Before we proceed, I would like to invite you to visit farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course, such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. The basic accounting equation, if you remember for a business, if the basic accounting equation, and I'm sure you know this, assets equal liabilities plus equity or stockholders equity. For government, we're going to see that assets, the way we look at the balance sheet or the accounting equation balance sheet, asset minus liabilities equal to net position, or we call it net asset. Another word, we might call it asset minus liabilities equal to the fund balance, and you will see why we call it the fund balance later on, but that's another word. So if you say, what's the fund balance, it's asset minus liabilities. You need to know this for future chapter, but that's a major difference. The way we look at the accounting equation, it's the same accounting equation, it's just rearrange. So what we're caring about is the difference between asset and liabilities for a business. What we're caring about is what are assets equal to liabilities and equities. Same thing presented in two different ways. Again, we're comparing businesses to government and not for not for profit. Also for government and not for profit entities, budget is very important. Budget is extremely, extremely important. That's the main document for a government. So they look at the budget. So the budget is the culmination of a political process for many small localities and cities. What they do most of the time, they spend most of the time on the budget to determine how to spend the money, because that's what matters. And you just heard what I said, how to spend the money. So the budget is basically how to spend the money, basically. So what happened is the expenditure, or expenditure, drives everything in the government situation. So what we do is, and the government, what they do is determine how much something should cost us. So notice what would happen first. We'll determine what's the cost of that something, the service. Then we'll try to generate revenue versus in a business, in a business, it's totally different. In a business, what you do first, you determine how much revenues you can generate, then expenses follow. So it's basically the opposite. And the cost for the government is reflected in the budget. So the expenditure, the cost, the expenses, drives the budget. And the budget is the most important, is the key physical document. Budgets drive accounting and financial reporting. So we're going to look later on how budgets are set up. But you need to know now, budget is a very important aspect of a governmental accounting. Also, revenues may not be linked to the voter's demand or satisfaction. So the way we generate revenue, it has nothing to do with satisfying, you know, providing a service to the voters so that can sit constituent. Again, those are the voters. So when we impose taxes, it doesn't mean if you pay more taxes, you're going to get more services that there is no link between you paying more taxes and getting more services. You have to pay taxes because you have to pay taxes. We impose on you as a government taxes, not because if you pay taxes, we're going to give you a better, a better product. OK, in a business, when you pay for something, you'll get better, better product, better service, but not for government. There is no link between those two. No direct link between revenues and expenses. Once again, as I said, in a government, you set the expenses first and you will try to raise revenues. And in theory, you want to break even because the government is not there to make a profit. The government is not there to make a profit. They want to earn, just they want to earn enough to cover their services. And also in government and not for profits, there is no distinction between internal and external accounting. And hopefully you remember from your financial accounting, we have, we learn about financial accounting versus, and you take another course called managerial accounting. Well, guess what? In government and not for profit, there is no distinction between what's called internal and external accounting. There's only one sets of accounting. And we're going to see later on the main reason for accounting is to the main reason for governmental accounting and not for profit is to hold the organization or the city or the government accountable to the constituents, whoever these are. Also, how do government and not for profit compare? You want to ensure equity and inter-period equity. So one of the key in government and not for profit is to ensure inter-period equity for most government and not for profit. Now, what is inter-period equity and what is this concept? What does it entail? Well, the concepts state that voters pay for services they received and not shift the burden to their children. That's what the government should try to achieve. They should try to achieve. That doesn't mean it's going to happen, but they should try to achieve inter-period equity. What does that mean? Let's assume in one year, let's assume 2017. In 2017, the city in which you live, they had higher snow accumulation than usual. So what they did, let's assume they budgeted 300,000 for the snow removal. That's 300,000 for that year, 2017. But in 2017, it was an unusual year and the government had to spend 400 and let's assume let's blow the budget, $750,000. Okay? So, because it snowed a lot, the snow accumulated, you need to remove it, open the road, make sure the roads are safe. What they did, they spent $750,000. Now, let's assume this locality or this city did not have the money to do the snow removal. What are they going to do? They are going to borrow it. So they're going to borrow the money today to make sure the roads are clean and safe. And what's going to happen after they borrowed the money? So let's assume they had to borrow $450,000. So they had to borrow the money. Now, they borrowed the money in 2017. What's going to happen? This money is going to be paid over the next five years. So what's going to happen? This money will be paid starting in 2018, 2019, 2020, 2021, and 2022. Well, what happened is this? If you really look at it, the people, the voters who are living in this city this year got the benefit. So the people got the benefit in 2017. So this is the benefit. This is when the benefit occur, when the roads were cleaned. But in the future to pay back the loan, the government decided to raise taxes. Remember, we have to pay for that $450,000. So what did we do? We raised the taxes. We raised the taxes to be able to pay off the loan. And let's also assume to make it even a more realistic example. The bank says, yes, I'm willing to lend you $450,000, but I want to show that you can raise the money. So you say, would raise the tax 0.2 percent. So we decided to raise the taxes 0.2 percent to pay for this $450,000 loan. So notice the people who are living in that city, 2018, 2019, 2020, 2021 and 2022 are paying for the people who got the benefit in 2017. So that's why in this example, inter-period equity is not achieved. Why? Because what happened in 2017, we shifted the burden. We shifted the burden to future years. So people who are living in that city in the next five years will have to pay for those services. So generally speaking, not generally speaking, one of the one of the goals of the government is to achieve this inter-period equity in a business. There is no such thing as inter-period equity. It doesn't have to be achieved in government. It has to be achieved. And the other thing when I think of we are not about the government, they're very they focus on short term. So notice here, they're going to borrow the money. It doesn't matter. They cannot defer this expense. For example, a business, if they have an expenditure, it's not critical. They made the further until next year or the following year. But for a government, it's short term focus. You need to clean the street. Otherwise, people are not going to be happy with this. OK, so so that's all we need by this. So it's very important that you understand what's inter-period equity. So the future generation are not paying for past generation expenditure. Resources may be restricted for particular activities or purpose. OK, what does that mean? When you contribute money, let's assume you contribute money to your school. Let's assume you contribute money to your school. That's a nonprofit organization. If you contribute money to your school, you can tell them, I want this money for this specific department. For example, your business department, economics department, accounting department, whatever department you would like to have that money restricted to. OK, and the government, for example, the government may may impose state gasoline tax for the sole purpose for the construction and maintenance of the highway. So that money that we collect from the gasoline tax, every time you fill up your car in gasoline in most states, they do have that tax. What happened? That tax cannot be used anywhere else, except for the construction and maintenance of the highway. So the resources, the revenues are restricted in the business. That's not the case. When you buy something from a business, they can use their money in any way they see fit. OK, for example, when the federal government grant loans, a grant grants money that doesn't have to be loans to a state government, they will tell them this money is specifically for low income housing. So the state or the county cannot use the money for anything else. Or if they give grants to nonprofit and say this money is specific for low income housing, so that nonprofit organization will have to specifically specifically use this money for for for low income housing. So the funds are restricted, the resources are restricted. That's not the case in in a business. OK, keep in mind the power ultimately rests in the hands of the people when it comes to the government and the business and the hands of the. Stockholders, citizen vote and delegate that power to elected official. Of course, that's how they do it. Exercise their sovereign power to collect taxes. So the government, how does the government raise money? They can raise taxes, they can raise taxes easy. If you want more money, you could raise taxes. That's how you generate revenue. Business, that's not the case. They'll be they'll be great if businesses could could could raise taxes. That's one of the main differences. Government can if they need revenue, they just raise the taxes and the voters will have to pay for the tax. Assuming they are legally elected, of course, if you don't like them, you could vote the next term and remove the government officials that they raise the taxes, but they have the right to do so. Businesses don't. Businesses, they generate revenue by providing goods and services. So it's much easier for the government. Now, bear in mind, raising taxes may not be easy all all the time for the for a government, because if the government is operating in a low income area, guess what? If you raise taxes, people, they might move and what end up happening, you raise the taxes now because you raise the taxes actually are collecting less revenue than expected. So to keep that in mind as well. So created by an accountable to a higher level of government, of course, always there is someone is accountable and the government for someone higher, but the highest is for the government is the voters and there are different reporting objectives between government and not for profit and business. And we're going to look at those reporting objectives. For example, in a business, what you need to do, you need to provide investors and creditors, if you remember, from your financial accounting courses and for financial information to make better decision to make business decision. That's the purpose of financial account, financial reporting objective for businesses. When it comes to government, the objective, it's going to be totally different. The objective, it's going to be accountability. The reason we provide financial information is to give the users information that they hold us accountable. And usually the accountability is based on the budget. Generally, what we do is we look at the budget. Okay, let's see what else. Basically, the next thing we look at is the objective of financial reporting for state and local government, okay, state and local government. But the first thing you want to know is that is how does the government and not for profit compare some comparison. Now, some similarities, if you want to think about similarities, state government or government in general, sometimes they do run entities like business like entities. For the state of Pennsylvania, they run, they run the liquor store across the state. So the liquor store, if you want to buy liquor, you have to go to the liquor store and the liquor store in the state of Pennsylvania is run by the government. And it's run as for, as it is as a for-profit entity. So they don't, they don't try to break even. They try to make a profit. And that's why the state of Pennsylvania wants to have a monopoly over the liquor, because there's a lot of profit in the liquor business. Therefore, the state government said we would run this business as a business for the people rather than we run it as a governmental entity to break even. Okay. So there are some similarities. It doesn't mean there's not similarities, but we looked at the main differences between the two. So in the next session, we look at the objective of financial reporting for state and local government. If you have any questions, any comments, by all means email me or see me in class, and by all means read your textbook and complete your homework.