A capital projects fund in governmental accounting is a temporary fund that tracks the financial resources restricted, committed, or assigned to building or acquiring major capital assets, such as courthouses, bridges, water treatment plants, fire stations, and large equipment.1GASB. Statement No. 54 of the Governmental Accounting Standards Board It opens when the money for a project starts arriving, follows every dollar through construction, and closes once the asset is in service and the last invoice has cleared.
The fund exists because public construction money almost always comes with legal strings attached. Bond covenants, grant agreements, and legislative appropriations all restrict how proceeds can be used, and segregating them in their own set of books is the cleanest way to prove compliance. Running a $30 million bridge project through the general fund would make that compliance nearly impossible to demonstrate.
What the Fund Tracks and What It Leaves Out
A capital projects fund uses the current financial resources measurement focus and the modified accrual basis of accounting, the same combination every governmental fund uses.2GASB. Summary – Statement No. 34 That drives what shows up on its statements.
The fund tracks cash and near-cash resources available to meet current obligations of the project. It deliberately excludes the long-lived asset being built and the long-term debt that financed it. The building itself and the bonds payable appear on the government-wide statements, not in the fund. The fund’s job is to show the money moving, not the asset standing.
Revenues are recognized when they are measurable and available, meaning collectible within the current period or within 60 days after year-end.3GASB. Summary of Interpretation No. 5 Property taxes assessed for a capital project but not collectible within that window are recorded as deferred inflows rather than current revenue. Expenditures are recognized when the related liability is incurred, not when cash leaves the account.4GASB. Summary of Interpretation No. 6 A contractor invoice becomes an expenditure the moment the liability is established.
One boundary worth naming: capital spending financed through proprietary funds, such as a water utility’s enterprise fund, does not run through a capital projects fund. Assets held in trust are also handled under their own fund structures.
Where the Money Comes From
Capital projects are typically too expensive for annual operating revenue to cover, so the financing picture is dominated by debt and restricted contributions.
Bond Proceeds
General obligation bonds and revenue bonds are the primary funding source for large projects. When the government receives cash from a bond sale, the fund records the amount as an “other financing source,” not as revenue. Revenue implies earned income; bond proceeds create a repayment obligation. Keeping them in separate categories prevents the fund from looking like it earned money it actually borrowed.
Grants and Intergovernmental Revenue
Federal and state grants restricted to capital spending also flow through the fund. Grant revenue is recognized once eligibility requirements are met and the funds are measurable and available. Expenditure-driven grants, where the government spends first and then draws down the award, shift recognition to the point of qualifying expenditure.
Interfund Transfers
If the government covers part of the project with money from its general fund or another fund, the capital projects fund reports that money as an “other financing source” too, keeping it distinct from earned revenue.
How Spending Is Controlled During the Project
The legally adopted budget sets the spending ceiling, and the accounting system has to enforce it. Three mechanisms do most of the work.
Encumbrances
When a government signs a construction contract or issues a purchase order, the committed amount is recorded as an encumbrance. That immediately reduces available spending authority, even though no expenditure has occurred yet. The purpose is to prevent officials from quietly overcommitting the fund by stacking contracts that together exceed the budget.
When the contractor later bills for completed work, the encumbrance is reversed and replaced with an actual expenditure. If the final cost comes in below the encumbered amount, the difference returns to available authority. If it comes in higher, the overage posts as an additional expenditure.
Capital projects routinely span multiple fiscal years, so outstanding encumbrances at year-end carry forward. Under GASB Statement No. 54, significant encumbrances are disclosed in the notes rather than shown as a separate balance sheet line, and encumbered amounts generally sit within the restricted or committed fund balance because the resources were already earmarked.1GASB. Statement No. 54 of the Governmental Accounting Standards Board
Retainage
Public construction contracts commonly let the government withhold a percentage of each progress payment, often 5 to 10 percent, until the work is substantially complete. The withheld amount is recorded as a retainage payable on the fund’s balance sheet. It protects the government if the contractor fails to finish or leaves defects, and it is released once final inspection and any punch-list items are resolved.
Interest During Construction
Interest incurred on construction borrowing is handled differently than many preparers expect. Under GASB Statement No. 89, interest incurred before the end of the construction period is recognized as an expense in the period incurred rather than capitalized into the asset’s cost, and this applies to enterprise funds as well as governmental activities.5GASB. Summary – Statement No. 89 In the capital projects fund itself, that interest posts as an expenditure under modified accrual, and it never gets folded into the building’s historical cost on the government-wide statements.
How the Fund Balance Is Classified
The fund balance on a capital projects fund balance sheet follows the five-tier hierarchy from GASB Statement No. 54.6GASB. Summary – Statement No. 54 In practice, most of the balance sits in the top two tiers.
- Restricted fund balance covers amounts that can only be spent for purposes dictated by external parties, constitutional provisions, or enabling legislation. Bond proceeds locked in by their covenants belong here.
- Committed fund balance covers amounts locked in by the government’s highest decision-making authority through a formal action such as an ordinance or resolution. Changing or undoing the commitment requires the same level of formal action.
- Assigned fund balance covers amounts intended for a specific purpose but without the formal constraint of committed or restricted resources. In a governmental fund other than the general fund, assigned fund balance is simply whatever remains after restricted and committed amounts are accounted for.
- Unassigned fund balance in a capital projects fund can only appear as a deficit, reflecting overspending against resources that were restricted, committed, or assigned.
Because capital projects money almost always arrives with strings attached, the typical fund balance is overwhelmingly restricted or committed.
Arbitrage Compliance When Bonds Are Tax-Exempt
If the project is financed with tax-exempt bonds, federal tax law imposes limits on how the proceeds can be invested before they are spent. Under 26 U.S.C. ยง 148, a bond loses its tax-exempt status if proceeds are invested in securities yielding more than the bond itself, making it an “arbitrage bond.”7Office of the Law Revision Counsel. 26 USC 148 – Arbitrage Losing that status is severe: bondholders suddenly owe federal income tax on their interest, the bonds become unmarketable, and future borrowing costs rise.
Even where higher-yielding temporary investments are permitted, excess earnings generally must be rebated to the U.S. Treasury.8Internal Revenue Service. Complying with Arbitrage Requirements: A Guide for Issuers of Tax-Exempt Bonds (Publication 5271) Rebate payments are due in installments at least every five years, with each installment covering at least 90 percent of the cumulative arbitrage earnings owed to that point, and a final payment is due within 60 days after the last bond in the issue is redeemed.7Office of the Law Revision Counsel. 26 USC 148 – Arbitrage
The IRS allows spending exceptions that let a government keep arbitrage earnings when proceeds are spent quickly enough. The most relevant one for capital projects is the two-year construction spending exception, available when at least 75 percent of proceeds will go to actual construction costs. Hit the prescribed spending benchmarks within two years and all investment earnings stay with the government. Miss any single benchmark and the entire exception is lost, with no catch-up provision, so slipping construction schedules carry real financial exposure. Shorter six-month and 18-month exceptions exist for other types of issues.
The practical consequence for fund accounting is that someone has to track arbitrage calculations throughout the life of the bonds, not just during construction. Many governments hire specialized consultants, and the cost is a legitimate expenditure of the capital projects fund or the debt service fund.
Closing the Fund
Once construction is complete, the asset is placed into service, and every final invoice and retainage payment has cleared, the fund closes. What happens to the remaining balance depends on whether the project came in under or over budget.
A positive balance (project under budget) usually transfers to the debt service fund to help pay down the bonds that financed the project, often because bond covenants or the authorizing legislation require it. Depending on the restrictions attached to the original funding sources, a surplus may instead revert to the general fund or move to another capital project.
A negative balance (costs exceeded available resources) is typically covered by a transfer from the general fund, which absorbs the shortfall so the capital projects fund can close at zero. That final transfer settles the books and the fund is dissolved.
Why the Fund’s Numbers Differ From the Government-Wide Statements
The capital projects fund and the government-wide statements describe the same transactions in different languages. GASB Statement No. 34 requires a formal reconciliation between them.9GASB. Statement No. 34 of the Governmental Accounting Standards Board The government-wide statements use the economic resources measurement focus and full accrual accounting, so they report all assets and all liabilities regardless of whether they are current.2GASB. Summary – Statement No. 34 Three big differences show up in the reconciliation.
First, the capital outlay expenditures reported in the fund are reclassified as a long-term capital asset on the government-wide statement of net position. The fund shows cash going out. The government-wide statement shows a building appearing on the books. Both describe the same event.
Second, bond proceeds that the fund reported as an “other financing source” are removed and replaced with a long-term liability. The fund treated the cash inflow as a financing event. The government-wide statements treat it as the creation of a decades-long debt obligation.
Third, once the asset is in service, the government-wide statements record depreciation to allocate the cost over its useful life. Depreciation never appears in the capital projects fund because the fund does not track long-lived assets. Infrastructure assets that are part of a network, such as a road system, may avoid depreciation if the government uses a qualifying asset management system and documents that the assets are being maintained at or above a disclosed condition level. Everything else depreciates on the standard schedule.