Understanding Proprietary Funds: Chapter 7

Proprietary Funds Basics

David Miller: Alright, welcome back to Government & Non-Profit Accounting. I'm David Miller, and as always, I'm joined by Maya Collins. Today we're diving into proprietary funds, which, if you remember from previous episodes, are one of the fundamental fund categories in government accounting. These are quite a bit different from the governmental funds we discussed before, so I think listeners will appreciate getting some clarity here.

Maya Collins: Yeah! And honestly, proprietary funds are probably the most relatable for folks who are used to looking at for-profit business statements, because the accounting is so similar. They're mainly funded by charges for services—it's that exchange transaction idea, right? You're paying for clean water, bus rides, things like that. And within proprietary funds, we've got two main players: internal service funds and enterprise funds.

David Miller: Exactly. The big difference between those two is essentially who they're serving. Enterprise funds are kind of like public-facing businesses. Their revenue mainly comes from transactions with folks outside the government. Your city water utility, public transit system—those are classic enterprise funds. Internal service funds, on the other hand, operate behind the scenes. They mostly serve other government departments, like a central IT or a city garage.

Maya Collins: Right, so, if you’re reading a government’s financial statements, you’ll see both these funds in the proprietary section, but the reporting splits a bit after that. Enterprise funds show up in the business-type activities column in government-wide statements, while internal service funds end up being reported in governmental activities. That always trips people up, because you’d expect all proprietary funds to go together, but nope!

Maya Collins: Actually, my first week analyzing city utility accounts, I remember thinking, “Wait a sec, this looks just like what I used to do over at the nonprofit—tracking revenue, measuring expenses, full accrual basis, all of it.” There’s way more overlap between enterprise fund bookkeeping and what you see in businesses or nonprofits than I expected. Kind of made me feel at home, actually.

David Miller: Well that’s probably the only time anyone’s felt "at home" reconciling utility ledgers, but—hey, I totally see what you mean. Full accrual accounting, economic resources focus, all the financial statements are there: statement of net position, revenues and expenses, cash flows. If you’re listening in and still getting tripped up by which fund goes where, circle back to our fund accounting basics episode. It builds the foundation to really understand why governments keep these buckets so separate. Alright, let’s get into one of those buckets: internal service funds.

Accounting & Financial Reporting for Internal Service Funds

Maya Collins: So David, let's break down how internal service funds, or ISFs, actually work in practice. The big thing for me is that they're set up by ordinance, so the city or county actually passes a law or resolution saying, "Yep, we need a garage fund or a central printing office," and then they decide where the money comes from to get things started. That could be a transfer from the General Fund, a loan, bond proceeds, sometimes a grant.

David Miller: Yeah, and once that’s established, it really runs like a business inside the government structure. Take the City of Ashville’s Central Garage Fund. To get things started, Ashville’s General Fund chipped in $300,000. Now, their garage provides repairs and space for all city vehicles. Their main revenue comes from billing other departments—like, “Hey, Parks Department, you owe us for that tune-up.” Grant revenue can show up too, but billings are really the engine.

Maya Collins: Right, so on the expenses side, you’re watching things like cost of supplies issued, admin, delivery, purchasing, depreciation, and of course, salaries and wages. The garage fund in Ashville, for example, had salaries totaling $235,000, and bought $92,000 worth of supplies just in one year! Supplies used was even higher—$110,000—which tells you they were working through last year’s inventory too.

David Miller: And Ashville’s Garage Fund had some interesting accounting details. Take their billings: they invoiced the General Fund and the Special Revenue Fund—so, other city units—for over $397,000 combined. Maintaining those "due from other fund" balances is a big job. They even had to track payments to the city’s own enterprise fund for utilities—talk about money moving in circles! Out of $30,000 in utility charges billed to them, they paid $27,000 and still owed a bit at year-end. All of this, by the way, gets squirreled away neatly through proper journal entries and closing processes. At the end of the year, they close temporary accounts to “Excess of Net Billings over Costs,” then roll that number into net position—usually unrestricted if there’s nothing externally restricted or tied up in capital assets.

Maya Collins: Honestly, tracing all those allocations is one of the most powerful audit tools out there. You can start to see if a certain department is overusing internal services, or if costs aren’t being spread fairly. David, you’ve probably spotted a few inefficiencies in your time following these trails, right?

David Miller: Oh, more times than I can count. If you notice, say, the IT department's share of expenses doubling year-over-year and nobody can explain why, that’s usually a smoke signal. Sometimes it’s just sloppy billing, sometimes it’s missing controls, and once in a while it's the first sign of outright fraud. I might be going on a bit of a tangent here, but that’s why tracing these allocations—looking at how they flow to other departments and eventually connect up on the government-wide statements—gives you a real sense of how efficiently the operation runs. Sound fund accounting is about more than compliance; it's about keeping the whole machine honest. Now, Maya, let’s switch gears and see how the picture changes for enterprise funds.

Enterprise Funds in Action

Maya Collins: So, enterprise funds—these are the units everybody interacts with, whether they realize it or not. Examples include water and sewer utilities, city transit, airports, public housing—if there's a fee for service, it probably runs through an enterprise fund. The revenue side is mostly user fees and charges for service, plain and simple. Though, as we touched on in earlier episodes, these funds still report in a way that parallels private business: full accrual, economic resources focus, all that.

David Miller: Yeah, and if you zoom in on the basic reporting cycle, it kicks off with recognizing accounts receivable. So, say a city water fund invoices customers—those unpaid bills sit in AR, and you include an allowance for uncollectible accounts, especially since not every customer pays on time. It's basically bad debt expense, just with government flavor. Then you move to recording operating expenses: maintenance, utilities, supplies, salaries, depreciation. Net position classifications work pretty much the same as ISFs—so you’ve got unrestricted, restricted, and net investment in capital assets, depending on how those assets or funds are tied up.

Maya Collins: Here's a practical example—I was looking at a city parking fund right out of school, and their collections were, let’s just say, not great. They had a mountain of unpaid tickets, so they had to set up a pretty hefty allowance for uncollectibles. In enterprise funds, that's a big deal, because the income statement needs to show that hit right away—you can't just hope people will magically pay up next year. In contrast, if internal service funds have outstanding "due from" balances, it's usually within departments, so collections are a little less dicey. If it doesn’t get paid, it just becomes a headache for the finance folks, not a hit to external income.

David Miller: That’s a good distinction. And I think it’s worth mentioning that enterprise funds, given their public-facing nature, are watched a bit more closely—late collections, high allowances, inconsistent fees, they all get noticed. But the real key is keeping your reporting transparent from the initial receivable down to closing entries and net position. If you do that, you not only stick to the standards, but you show the public—or in our case, students—what it takes to run these services sustainably.

Maya Collins: Exactly! So, I think that's a solid rundown for today. If you’re still puzzling over the nitty-gritty, you can always revisit our earlier episodes on government financial statements and fund accounting basics. It's all about building those layers of understanding one episode at a time.

David Miller: That’s right. And as you keep listening, you’ll find these pieces start to fit together. Next time, we’ll dig into capital assets in proprietary funds, which, believe me, gets even more interesting. Maya, always a pleasure—

Maya Collins: You too, David. Thanks everyone for tuning in, and see you next episode!