Enterprise Fund Accounting System
Since its inception in 1996, Pioneer Consulting Group has assisted municipalities in establishing enterprise fund accounting systems.
What is an Enterprise Fund?
An enterprise fund establishes a separate accounting and financial reporting mechanism for municipal services for which a fee is charged in exchange for goods or services. Under enterprise accounting, the revenues in expenditures of services are separated into separate funds with its own financial statements, rather than integrated with all the other revenues and expenses of all other government activities.
Enterprise funds may be established for a utility, health care, recreational, or transportation facility. These are:
- Public Utilities - Water, sewer, and trash disposal
- Healthcare - Ambulance service and nursing homes
- Recreation - Skating rinks, pools, and golf courses
- Transportation - Airports, docks, and wharf facilities
The community may not establish enterprise funds for normal government operations or services such as building rentals, inspectional services, or cemeteries. Establishing an enterprise fund does not create a separate or autonomous entity from the municipal government’s operation. The municipal department operating the enterprise service continues to fulfill financial and managerial reporting requirements like every other department.
Financial transactions are reported using standards similar to private sector accounting. Revenues are recognized when earned while expenses are recognized when incurred under a full actual basis of accounting.
An enterprise fund provides management and taxpayers with information to:
- Measure performance
- Analyze the impact of financial decisions
- Determine the cost of providing a service
- Identify any subsidy from the general fund in providing a service
Enterprise accounting allows the community to demonstrate to the public the portions of the total costs of a service recovered through user charges and, if any, the portion that is subsidized by tax levies or other available funds. A community may choose to recover total services costs through user charges, but is not required to. Enterprise funds are frequently used to account for services with costs that are partially funded by fees and charges.
At year’s end, the performance of an enterprise fund is measured in terms of positive and negative operations. An operating surplus is a result of revenues collected in excess of estimates and appropriation turn backs, and translates into retained earnings that are maintained in the fund rather than closing itself to the general fund.
Retained earnings of an enterprise fund are certified as available funds after submission of the end-of-the-year balance sheet to state government. Once certified, retained earnings may be appropriated only for expenditures relating to the fund.
Conversely, if during the year, the enterprise fund incurs an operating loss, the loss must be raised in the subsequent year's budget.
Adopting an Enterprise Fund
Generally, a city or town may adopt an enterprise fund approved through a city council vote or a town meeting. Each enterprise fund must be adopted separately with its own vote. This allows municipal legislative bodies to identify and evaluate each enterprise on its own merit.
We recommend that the community accept the enterprise statute in advance of the budget process and clearly state what services will be provided and when the fund will commence. Unless otherwise designated, the enterprise fund will commence as of the next fiscal year after it has received town meeting approval.
Once adopted, the community may begin the process of transferring the estimated revenues and operating budget of the services and identifying the assets (capital items in infrastructure) and liabilities in the general fund to be transferred to the enterprise fund.
The following is sample language to adopt for an enterprise fund: "To see if the (NAME) will accept the provisions of Chapter XX, Section XX of the XXXXXX General Laws, establishing (the service) as an enterprise fund effective fiscal year (year)."
The Enterprise Budget
Once an enterprise fund is enacted, a budget is subject to the appropriation process. A request is prepared like any other department’s request for review and eventual adoption.
Any transfers among the enterprise fund's line-item appropriations also require action by town meeting stakeholders. The enterprise budget includes both revenue and expenditure estimates.
Similar to any operating department, revenue estimates are prepared. These may include user charges and fees, investment income, and any other enterprise revenues. All enterprise revenues may only be used to support the expenditures of the enterprise fund. At no time may these funds be used to support ongoing municipal operations or subsidize the general fund.
All enterprise operation costs must be identified. This should include direct costs, indirect costs, employee benefits, legal and borrowing costs, as well as capital expenditures. These costs may also include an appropriation for emergency reserve and a budget surplus.
- Direct costs are those associated directly to the enterprise fund. Generally, these include salaries and wages of the enterprise’s employees, other operating expenses, and contractual payments. These expenditures will be appropriated in and incurred directly by the enterprise fund.
- Indirect costs are those costs that cannot be directly or exclusively assigned to one service. Enterprises often benefit from expenditures made by the general fund. For example, a collector whose salaries are paid by the general fund, make process enterprise user-billed payments. We recommend that these indirect costs be identified and allocated to the enterprise fund using clearly established formulas to prorate the expense among departments. Because indirect costs are appropriated in the general fund, any operating transfer is made by the auditor/accountants to reimburse the general fund from the enterprise fund. Ideally, these operating transfers are made monthly to ensure that the enterprises transferring revenues to provide for the general fund expenditures as they are made. All operating transfers from the enterprise fund are credited to the general fund's cash account. At no time is an operating transfer used to replenish an operating department appropriation.
- Employee benefits include health and life insurance, FICA and medical expenses, workers compensation, unemployment insurance, and pension and retirement costs. These expenditures are generally budgeted in the general fund (or insurance trust funds) for all employees including those of the enterprise fund. Therefore, the enterprise portion of these expenses, like the indirect costs, must be allocated to the enterprise fund.
- Legal and borrowing costs may be appropriated or budgeted for directly in the enterprise on area. These include debt service costs (principal, interest, and temporary borrowing costs), bond counsel expenditures relating to an enterprise debt issuance and/or financial service costs relating to a bond and the bonded prospectus. Alternatively, these expenditures are currently provided for in the treasurer or debt services’ budgets and must be allocated to the enterprise fund appropriately.
- Capital expenditures or improvements are items generally found in a capital budget such as construction or major repairs, equipment, or acquisitions. While these items may be reviewed and recommended generally by the capital planning committee, it is advisable that the capital expenditures for the enterprise are voted separately from the general fund's capital expenditures.
- Emergency reserve, like the general fund’s reserves, is an appropriation available to meet unanticipated spending needs that may arise during the course of the year, which would require immediate action. Following the same guidelines set forth in the general fund, the reserve may be transferred by the city council or finance committee action rather than having to wait for the next scheduled legislative meeting. There should be no direct charge for the emergency reserve and the auditor or accountant should transfer the amounts to the line item as stated in the approved transfer. At the close of the fiscal year, any remaining balance in this emergency reserve would close to the enterprise fund balance.
- Budgeted surplus is an appropriation within the enterprise budget established as an available revenue source during the budget year. Generally, a budgeted surplus is established when the prior year's enterprise operation resulted in little or no retained earnings. Without sufficient surplus available for appropriation, the community may have to use its general fund revenues to fund/subsidize the enterprise if additional enterprise expenses incurred exceed available resources. Alternatively, the community may increase its user fees and charges and appropriate the new estimated revenues to a budget surplus available for use if the need arises.
- The budget surplus may be used to fund additional spending after the community's tax rate is set and is subject to the appropriation process by the municipal legislative body. It should be further noted that because there is no legal authorization for the continuing balance or the establishment of a stabilization fund in an enterprise fund, any remaining balance in this budgeted surplus would close to the fund balance of the enterprise fund at the close of fiscal year.
- Another cost of the enterprise not included in the operating budget is depreciation of the fixed assets and infrastructure. While it is not a budgetary item, depreciation should be considered by the community when preparing a cost analysis to determine charges and fees. Depreciation is calculated in order to recognize the annual expense associated with the use of an asset is a given reporting period. In general, depreciation is calculated by dividing the purchase price of the asset by its useful life. If the asset has outstanding debt and a debt service is already budgeted, depreciation is not included in the costing analysis because it would result in a double counting of expenses.
What are the Advantages of Enterprise Fund Accounting?
A community may account for certain services in the general fund, special revenue fund, or enterprise fund. The advantages of using an enterprise fund rather than the other two methods are as follows:
- Demonstrate Total Cost of Service - With all the direct, indirect (e.g., interdepartmental support, health, and insurance costs) and capital cost of providing the service in a consolidated fund, the community will be able to readily identify the true cost of providing a service, in this case, for water supply, storage, and distribution
- Provide Useful Management Information - With the consolidation of revenues and the cost of services and information on the operating performance (positive or negative) of the fund, the community will have useful information to make decisions on user charges and other budgetary items. The community will be able to analyze how much the user fees and charges support the services and to what extent if any tax levy or other available revenues are needed to subsidize the enterprise fund. The community will also be able to include the fixed assets and infrastructure of the enterprise as assets in the financial statement and recognize the annual depreciation of these assets.
- Retain Investment Income and Surplus - Unlike services operating in the general fund or a special revenue fund, all investment earnings and any other operating surplus are retained in the enterprise fund rather than returned to the general fund at the end of the year. Once a surplus is certified as available (similar to free cash), it may be used to fund operating, capital or debt service costs associated with the enterprise.
- Provide Better Ability to Implement Capital Improvements - The enterprise fund will allow the department providing the service to better plan for and implement capital improvements. These needs can be forecast and integrated into the long-term financial management of the department.
Why would a community choose to adopt an enterprise fund?
- To be able to determine the total cost of providing a service
- To demonstrate to the public which portion of the total cost of a service is covered through user charges vs. tax levy
- To allow the surplus or retained earnings generated by the operation of the enterprise to remain with that fund rather than close out at year-end to the general fund and become part of "free cash". The surplus may be used to help fund future capital expenditures such as water replacement costs or to reduce rates
- To prevent town officials from taking predatory action against water department revenues
Does an enterprise fund have to fully recover its costs through user fees or be self-sufficient?
No. An enterprise fund may be self-supporting or it may be subsidized (e.g., debt and capital exclusions) by the general fund. The extent to which it is subsidized is a policy decision that should be clearly identified when the town meeting is requested to adopt the enterprise fund budget.
Does the amount of the proposition 2 debt exclusion for an enterprise fund have to be reduced by the amount of any user fees and/or special assessments imposed for the same project?
(Note: This applies to MA only)
No. If the debt service for an enterprise project is funded through user fees, betterments, or other local revenues, a community has the option of excluding a lesser amount by reporting the principal and interest net of the local revenue. However, if the community chooses to exclude the gross debt service amount instead, it must budget that property tax subsidy to the enterprise fund. The increase in allowable levy attributable to the exclusion cannot be spent for any other purpose.
When a community adopts enterprise fund, is it subject to the appropriation process?
Yes. The community is responsible for appropriating all enterprise fund costs and identifying the revenue source from which these will be funded. The information is recorded on the tax rate recapitulation sheet.
Can enterprise fund use its retained earnings/surplus to pay for the expenditures that the town meeting voted to fund by borrowing?
No. The enterprise's retained earnings (or surplus) cannot be spent without appropriation nor can the town meeting’s decision about funding sources for expenditures be reversed by the enterprise fund. It would require another town meeting vote to change the funding source.
For what purpose can the community use budget surplus and/or retained earnings?
The community can choose to appropriate budget surplus and retained earnings:
- Operating costs to offset the need to increase user charges
- Capital improvements
- Reimbursement to the general fund to the extent that the general fund has provided subsidy to that particular service in the past (which requires detailed documentation)
- Enterprise revenue deficits (operating loss)
Can an enterprise fund operate independently under its own procedures?
An enterprise fund is just an accounting and/or budgeting tool. It does not grant additional powers to the department providing service. The enterprise fund is still a municipal department and is still subject to governing finance procedures on that level. The rate setting process is established by statute or local charter.
Property and assets included in the enterprise fund is owned by the municipality and may only be acquired, leased or disposed of by vote of the town meeting. At no time can these conditions be altered through the adoption of enterprise.
Should services provided by other departments be billed directly to the enterprise fund? Are other indirect costs like health insurance charged directly to the enterprise fund?
No. Any services provided by other departments and indirect expenses/charges should be reimbursed to the general fund through inter-fund transfers from the enterprise fund. Ideally, these transfers should be done monthly so that the enterprise fund expenses are tracked and its financial position is accurately reflected.
What happens if there is a disagreement on indirect costs (e.g., which expenses and how much) of an enterprise fund?
Indirect and allocated costs should be clearly set forth (e.g., what costs will be shared and how much) when the budget is adopted to avoid disputes later in the fiscal year. If, however, the enterprise still cannot agree with the community's financial officials on what figure should be used for indirect and allocated costs, the appropriate body to resolve the matter is the town meeting.
How does the community provide for an enterprise operating loss?
Any operating loss will be provided for in the subsequent year's enterprise fund budget. This may be refunded by the enterprise revenues or available funds, or possibly, a general fund subsidy.
How can an enterprise fund provide for extraordinary or other unforeseen expenditures?
- The community may establish an emergency reserve for extraordinary or unforeseen expenditures similar to the general fund reserve fund
- The community may establish the enterprise budgeted surplus which is subject to the appropriation process with the approval of town meeting
- Town meeting may appropriate from this emergency reserve fund and/or retained earnings
- The department may request a transfer from the general fund reserve fund. The enterprise fund may later appropriate to reimburse the general fund for such transfer
- The community may request authorization to spend in excess of authorization under an emergency that poses an immediate threat to the health or public safety of persons or property
Can the town meeting vote be used on enterprise funds for purposes not related to the enterprise?
No. The enterprise enabling statute provides that the enterprise remedies may only be used for enterprise-related expenses. Even if there is an understanding, funds will be reimbursed to the enterprise. A community cannot use the enterprise fund as funding source for appropriations to pay for unrelated municipal expenses or for inter-fund borrowing for cash flow purposes.
What happens if the community decides it no longer wants to have an enterprise fund?
After at least 3 years, the legislative body of the can vote to terminate the enterprise fund. Once it ceases operation and all of the current liabilities are accounted for, the community would close any fund balance to the general fund. Assets, debt, and long-term liabilities will be transferred to the general fund.