Richmond City Council
May 2, 2023

In the context of nancial reporting, the term fund balance is used to describe the net position of governmental funds calculated in accordance with generally accepted accounting principles (GAAP).

Budget professionals commonly use this same term to describe the net position of governmental funds calculated on a government’s budgetary basis.
1 While in both cases fund balance is intended to serve as a measure of the nancial resources available in a governmental fund; it is essential that dierences between GAAP fund balance and budgetary fund balance be fully appreciated.

1. GAAP nancial statements report up to ve separate categories of fund balance based on the type and source of constraints placed on how resources can be spent (presented in descending order from most constraining to least constraining):
nonspendable fund balance, restricted fund balance, committed fund balance, assigned fund balance, and unassigned fund balance.2 The total of the amounts in these last three categories (where the only constraint on spending, if any, is imposed by the government itself) is termed
unrestricted fund balance. In contrast, budgetary fund balance, while it is subject to the same constraints on spending as GAAP fund balance, typically represents simply the total amount accumulated from prior years at a point in time.

2. The calculation of GAAP fund balance and budgetary fund balance sometimes is complicated by the use of sub-funds within the general fund. In such cases, GAAP fund balance includes amounts from all of the subfunds, whereas budgetary fund balance typically does not.

3. Often the timing of the recognition of revenues and expenditures is dierent for purposes of GAAP nancial reporting and budgeting. For example, encumbrances arising from purchase orders often are recognized as expenditures for budgetary purposes, but never for the preparation of GAAP nancial statements.

BEST PRACTICES
Fund Balance Guidelines for the
General Fund
Governments should establish a formal policy on the level of unrestricted fund balance that should be maintained in the general fund for GAAP and budgetary purposes.

Attachment 6 - GFOA General Fund Fund-Balance Guidelines The eect of these and other dierences on the amounts reported as GAAP fund balance and budgetary fund balance in the general fund should be claried, understood, and documented.

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.  In most cases, discussions of fund balance will properly focus on a government’s general fund. Nonetheless, nancial resources available in other funds should also be considered in assessing the adequacy of unrestricted fund balance in the general fund.

GFOA recommends that governments establish a formal policy on the level of unrestricted fund balance that should be maintained in the general fund for GAAP and budgetary purposes. 3 Such a
guideline should be set by the appropriate policy body and articulate a framework and process for how the government would increase or decrease the level of unrestricted fund balance over a specic time period.4In particular, governments should provide broad guidance in the policy for how resources will be directed to replenish fund balance  should the balance fall below the level prescribed.

Appropriate Level.  The adequacy of unrestricted fund balance in the general fund should take into account each government’s own unique circumstances. For example, governments that may be vulnerable to natural disasters, more dependent on a volatile revenue source, or potentially subject to cuts in state aid and/or federal grants may need to maintain a higher level in the unrestricted fund balance.  Articulating these risks in a fund balance policy makes it easier to explain to stakeholders the rationale for a seemingly higher than normal level of fund balance that protects taxpayers and employees from unexpected changes in nancial condition. Nevertheless, GFOA recommends, at a minimum, that general-purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures.
5 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 signicantly 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:

1. The predictability of its revenues and the volatility of its expenditures (i.e., higher levels of unrestricted fund balance may be needed if signicant revenue sources are subject to unpredictable Attachment 6 - GFOA General Fund Fund-Balance Guidelines uctuations or if operating expenditures are highly volatile);

2. Its perceived exposure to signicant one-time outlays (e.g., disasters, immediate capital needs, state budget cuts);

3. The potential drain upon general fund resources from other funds, as well as, the availability of resources in other funds;

4. The potential impact on the entity’s bond ratings and the corresponding  increased cost of borrowed funds;

5. 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 specic purpose).  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.

Use and Replenishment.

The fund balance policy should dene conditions warranting its use, and if a fund balance falls below the government’s policy level, a solid plan to replenish it. In that context, the fund balance policy should:

1. Dene the time period within which and contingencies for which fund balances will be used;

2. Describe how the government’s expenditure and/or revenue levels will be adjusted to match any new economic realities that are behind the use of fund balance as a nancing bridge;

3. Describe the time period over which the components of fund balance will be replenished and the means by which they will be replenished.

Generally, governments should seek to replenish their fund balances within one to three years of use.

Specically, factors inuencing the replenishment time horizon include:

1. The budgetary reasons behind the fund balance targets;

2. Recovering from an extreme event;

3. Political continuity;

4. Financial planning time horizons;

5. Long-term forecasts and economic conditions;

6. External nancing expectations.

Attachment 6 - GFOA General Fund Fund-Balance Guidelines Revenue sources that would typically be looked to for replenishment of a fund balance include nonrecurring revenues, budget surpluses, and excess resources in other funds (if legally permissible and there is a defensible rationale).  Year-end surpluses are an appropriate source for replenishing fund balance.

Unrestricted Fund Balance Above Formal Policy Requirement.  In some cases, governments can nd themselves in a position with an amount of unrestricted fund balance in the general fund over their formal policy reserve requirement even after taking into account potential nancial risks in the foreseeable future.  Amounts over the formal policy may reect a structural trend, in which case governments should consider a policy as to how this would be addressed.  Additionally, an education or communication strategy, or at a minimum, explanation of large changes in fund balance is encouraged. In all cases, use of those funds should be prohibited as a funding source for ongoing recurring expenditures.

Notes:

1. For the sake of clarity, this recommended practice uses the terms GAAP fund balance and budgetary fund balance to distinguish these two dierent 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 Denitions.

3. Sometimes restricted fund balance includes resources available to nance 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.

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 nancial 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 signicantly 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 fty), and because their revenues and expenditures often are more diversied 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 Attachment 6 - GFOA General Fund Fund-Balance Guidelines made to compare unrestricted fund balance to either revenues and/or expenditures, that decision should be followed consistently from period to period.

This best practice was previously titled Appropriate Level of Unrestricted Fund Balance in the General Fund.

Board approval date: Wednesday, September 30, 2015
Attachment 6 - GFOA General Fund Fund-Balance Guidelines