Governmental accounting is the system state and local governments use to track public money and prove they spent it only as the law allowed. It rests on two features that set it apart from corporate bookkeeping: standards written by the Governmental Accounting Standards Board (GASB), and a fund structure that walls restricted dollars off from general spending. The point is compliance, not profit. A city’s books exist to show voters, auditors, grantors, and bondholders that every dollar went where it was legally supposed to go.
What GASB Is and Why Its Standards Stick
GASB is the independent body that writes Generally Accepted Accounting Principles (GAAP) for U.S. state and local governments.1Governmental Accounting Standards Board. About the GASB The Financial Accounting Standards Board (FASB) handles the private sector; GASB handles public entities. Its pronouncements shape how thousands of jurisdictions record transactions, value assets, disclose liabilities, and present results.
The most consequential of those pronouncements, GASB Statement No. 34, overhauled government financial reporting by requiring two layers of statements. Government-wide statements use the full accrual basis and report all assets, liabilities, revenues, and expenses much the way a corporation would. Fund-level statements use the modified accrual basis and focus on short-term resources available to pay current bills. Statement No. 34 also required governments to capitalize infrastructure like roads and bridges, and to include a management’s discussion and analysis (MD&A) giving readers a plain-language overview of the year.2Governmental Accounting Standards Board. Summary – Statement No 34 – Basic Financial Statements and Managements Discussion and Analysis for State and Local Governments
GASB has no enforcement power of its own. Compliance is compelled by the bond market and by state laws that require GAAP-based reporting. Investors and rating agencies expect audited statements that follow GASB standards; noncompliant reporting can raise borrowing costs or trigger audit findings that jeopardize grant funding.
How Fund Accounting Works
The defining feature of governmental accounting is fund accounting. Each fund is a self-contained accounting unit with its own assets, liabilities, revenues, and balances.3National Center for Education Statistics. Financial Accounting for Local and State School Systems – Section: Fund Structure A city’s gasoline tax revenue earmarked for road repairs sits in a separate fund from general operating cash. That separation is the point. It prevents legally restricted money from being quietly redirected to cover a shortfall somewhere else.
A single city or county may maintain dozens of individual funds at once. The complexity is intentional: it gives administrators, auditors, and the public granular visibility into compliance with grant terms, bond covenants, and local ordinances.
The Three Types of Funds
Funds fall into three broad categories.
- Governmental funds cover the core tax-funded services people associate with government: police, fire, parks, road maintenance, and general administration. They are financed primarily through taxes and intergovernmental grants and use the modified accrual basis. The general fund, special revenue funds, capital project funds, debt service funds, and permanent funds all sit here.
- Proprietary funds account for activities that operate more like businesses, charging fees to cover their costs. A municipal water utility or a public parking system is a typical example. They use full accrual, measuring net income and cash flows much like a private company would. Enterprise funds serve external customers; internal service funds serve other departments.3National Center for Education Statistics. Financial Accounting for Local and State School Systems – Section: Fund Structure
- Fiduciary funds hold resources the government manages on behalf of someone else, such as a pension trust for retired employees or an investment pool for other local governments. Because the government does not own these assets, fiduciary funds are excluded from the government-wide statements to avoid overstating the entity’s net worth.
Not every fund gets equal billing. The general fund is always reported individually as a “major fund.” Other funds qualify as major when their assets, liabilities, revenues, or expenditures cross set percentage thresholds relative to their fund category and the government as a whole. The rest are aggregated into a single “other” column.
Two Bases of Accounting, Two Questions
Governmental funds record transactions on the modified accrual basis, which zeroes in on short-term, spendable resources. Revenue is recognized only when it is both measurable and available. “Measurable” means the government can pin down a specific dollar amount. “Available” means the cash will arrive in time to pay current obligations, typically within 60 days after the fiscal year ends, though governments can define a different availability window.4Governmental Accounting Standards Board. Summary – Statement No 33 – Accounting and Financial Reporting for Nonexchange Transactions
Expenditures are generally recorded when the related liability comes due. Long-term debt is a notable exception: principal and interest payments on bonds are not recognized as governmental fund expenditures until they mature.5Governmental Accounting Standards Board. Summary of Interpretation No 6
The government-wide statements, by contrast, use full accrual. Revenue is recognized when earned and expenses when incurred, regardless of when cash moves. That dual-basis structure is what makes governmental accounting distinctly complex. The same government reports its finances two different ways because each answers a different question. Fund-level statements ask whether the government can pay this year’s bills. Government-wide statements ask whether it is better or worse off overall.2Governmental Accounting Standards Board. Summary – Statement No 34 – Basic Financial Statements and Managements Discussion and Analysis for State and Local Governments
Fund Balance and Net Position
Within governmental funds, the leftover after subtracting liabilities is called fund balance. GASB Statement No. 54 requires governments to break it into five categories that signal how freely the money can be spent:6Governmental Accounting Standards Board. Summary – Statement No 54 – Fund Balance Reporting and Governmental Fund Type Definitions
- Nonspendable resources cannot be spent because of their form (inventories, prepaid items) or because they must be maintained intact.
- Restricted money can only be spent for a purpose dictated by an external party such as a grantor, creditor, or constitutional provision.
- Committed money is set aside for a specific purpose by the government’s highest decision-making authority through a formal action like a resolution. Only that same authority can reverse the commitment.
- Assigned money is intended for a particular purpose but lacks the formal constraints of a commitment. In non-general funds, any remaining balance that is not restricted or committed defaults to assigned.
- Unassigned is the residual balance in the general fund after all other classifications. Only the general fund should report a positive unassigned balance; other funds use this classification only when they carry a deficit.
At the government-wide level and in proprietary funds, the equivalent measure is net position, split into three categories: net investment in capital assets (equity in buildings, infrastructure, and equipment after related debt), restricted, and unrestricted. Bondholders and analysts use these classifications to gauge how much financial flexibility the government actually has.
Budgets, Appropriations, and Encumbrances
Budgets carry legal force in government. When a legislature or governing board adopts an appropriation, it grants legal authority to spend a specific amount on a specific purpose. Spending beyond that authorization is not just poor practice; in most jurisdictions it violates the law. Governmental accounting reflects this by integrating budgetary accounts directly into the general ledger, so administrators can compare actual results against appropriations throughout the year.
Encumbrance accounting is the mechanism that prevents overspending. When a department issues a purchase order or signs a contract, an encumbrance is recorded against the relevant appropriation. That encumbrance is not yet an expense, and no money has left the building. It reserves a portion of the budget so the remaining available balance is accurate. A department with a $500,000 appropriation that has spent $300,000 and has $150,000 in outstanding purchase orders has $50,000 truly available, not $200,000.
Encumbrances outstanding at year-end do not count as expenditures or liabilities. They represent the estimated cost of contracts still in progress. Governments typically disclose significant year-end encumbrances in the notes, and the related fund balance is classified as committed or assigned rather than unassigned. Once the goods or services arrive, the encumbrance converts to an actual expenditure.
The Annual Comprehensive Financial Report
The annual output of all this bookkeeping is the Annual Comprehensive Financial Report, or ACFR. The name was changed from “Comprehensive Annual Financial Report” in 2021.7Governmental Accounting Standards Board. GASB Changes Name of Report to Annual Comprehensive Financial Report The ACFR is the fullest picture of a government’s financial health, and it follows a standardized structure so readers can compare reports across jurisdictions.
The report has three main sections. The introductory section includes a transmittal letter from management, an organizational chart, and a list of principal officials. The financial section is the core: independent auditor’s opinion, MD&A, government-wide financial statements, fund financial statements, and notes. The statistical section closes the document with ten years of trend data on financial indicators, revenue capacity, debt levels, and demographic and economic conditions.8National Center for Education Statistics. Contents of a Comprehensive Annual Financial Report
The MD&A is required supplementary information that must precede the basic financial statements and give an objective, readable analysis of results. Under GASB Statement No. 103, which takes effect for fiscal years beginning after June 15, 2025, the MD&A must be organized into five specific sections: an overview of the financial statements, a financial summary, detailed analyses, a discussion of significant capital asset and long-term financing activity, and a section on currently known facts, decisions, or conditions. The standard explicitly discourages boilerplate, requiring management to explain why balances and results changed rather than simply reciting the amounts.9Governmental Accounting Standards Board. Summary – Statement No 103 – Financial Reporting Model Improvements
Most states require local governments to file their annual reports within 90 to 120 days after the fiscal year ends, though specific deadlines vary.
Recent Standards on Leases and Software Subscriptions
Two recent GASB pronouncements have significantly expanded what appears on government balance sheets. Statement No. 87, effective for fiscal years beginning after June 15, 2021, eliminated the old distinction between operating leases and capital leases. Under the new rule, virtually every lease is treated as a financing arrangement. A government that leases office space, vehicles, or equipment must recognize both a long-term liability (the present value of future lease payments) and an intangible right-to-use asset.10Governmental Accounting Standards Board. Summary – Statement No 87 – Leases Net position does not change because the asset and liability offset each other, but debt ratios can look worse, which matters for bond ratings.
Statement No. 96, effective for fiscal years beginning after June 15, 2022, applies similar logic to cloud-based software subscriptions. When a government pays for multi-year access to a vendor’s software platform, it recognizes an intangible subscription asset and a corresponding liability, just like a lease. Short-term arrangements lasting 12 months or less are exempt and simply expensed as incurred. Implementation costs during initial setup are capitalized; training and ongoing maintenance are expensed.11Governmental Accounting Standards Board. Summary – Statement No 96 – Subscription-Based Information Technology Arrangements
Statement No. 103 is the most sweeping update to the financial reporting model since Statement No. 34. Beyond restructuring the MD&A, it makes broader changes to how governments present fund-level and government-wide information. For most governments on a July-through-June fiscal year, the first reports under Statement No. 103 will cover fiscal year 2026.9Governmental Accounting Standards Board. Summary – Statement No 103 – Financial Reporting Model Improvements
Single Audits and Federal Oversight
Any government that spends $1,000,000 or more in federal awards during a fiscal year must undergo a Single Audit. That threshold was raised from $750,000 effective for fiscal years ending September 30, 2025 and later.12eCFR. 2 CFR Part 200 Subpart F – Audit Requirements Governments below the threshold are exempt from federal audit requirements, though state audit mandates may still apply.
A Single Audit goes beyond a standard financial audit. In addition to opining on the financial statements, the auditor tests whether the government complied with federal program requirements for its major federal awards. The federal Compliance Supplement identifies 12 categories of compliance requirements, covering matters like whether costs charged to grants were allowable, whether the government properly determined participant eligibility, and whether required reports were filed on time. Auditors focus their compliance testing on the government’s largest and highest-risk federal programs.
Findings can have real consequences. Material weaknesses or noncompliance may lead federal agencies to impose additional grant conditions, demand the return of misspent funds, or designate the entity as “high risk” for monitoring. Audit reports go to the Federal Audit Clearinghouse, where they become publicly accessible.
SEC Oversight of Municipal Bond Disclosures
Governments that issue municipal bonds face a separate layer of accountability through the Securities and Exchange Commission. Under SEC Rule 15c2-12, underwriters cannot purchase or sell municipal bonds unless the issuer has committed to providing continuing disclosure, including annual financial information and timely notice of certain material events such as payment delinquencies, rating changes, or draws on debt service reserves.13eCFR. 17 CFR 240.15c2-12 – Municipal Securities Disclosure
The SEC can bring enforcement actions against issuers or underwriters who make materially inaccurate statements in bond offering documents about compliance with these disclosure obligations. Underwriters cannot simply accept a written certification from the issuer at face value; they are expected to independently verify the issuer’s filing history.14U.S. Securities and Exchange Commission. Municipalities Continuing Disclosure Cooperation Initiative This is where GASB standards and securities regulation meet. A government that falls behind on its ACFR or fails to file annual financial data with the Municipal Securities Rulemaking Board’s EMMA system may find underwriters unwilling to bring its next debt issuance to market, effectively locking it out of capital markets until its disclosure record is cleaned up.