Reference no: EM132725338

Question - Government activities may be less "profitable" than they appear.

A city prepares its budget in traditional format, classifying expenditures by fund and object. In 2010, amid considerable controversy, the city authorized the sale of $20 million in bonds to finance construction of a new sports and special events arena. Critics charged that, contrary to the predictions of arena proponents, the arena could not be fiscally self-sustaining. Five years later, the arena was completed and began to be used. After its first year of operations, its general managers submitted the following condensed statement of revenues and expenses (in millions):

Revenues from ticket sales 5.7

Revenues from concessions 2.4

8.1

Operating expenses 6.6

Interest on debt 1.2

7.8

Excess of revenues over expenses 0.3

At the city council meeting, when the report was submitted, the council member who had championed the center glowingly boasted that his prophecy was proving correct; the arena was "profitable." Assume that the following information came to your attention:

The arena is accounted for in a separate enterprise fund.

The arena increased the number of overnight visitors to the city. City administrators and economists calculated that the additional visitors generated approximately $0.1 million in hotel occupancy tax revenues. These taxes are dedicated to promoting tourism in the city. In addition, they estimated that the ticket and concession sales, plus the economic activity generated by the arena, increased general sales tax revenues by $0.4 million.

The city had to improve roads, highways, and utilities in the area surrounding the arena. These improvements, which cost $6 million, were financed with general obligation debt (not reported in the enterprise fund). Principal and interest on the debt, paid out of general funds, were $0.5 million. The cost of maintaining the facilities was approximately $0.1 million.

On evenings when events were held in the arena, the city had to increase police protection in the arena's neighborhood. Whereas the arena compensated the police department for police officers who served within the arena itself, those who patrolled outside were paid out of police department funds. The police department estimated its additional costs at $0.1 million.

The city provided various administrative services (including legal, accounting, and personnel) to the arena at no charge at an estimated cost of $0.1 million.

The city estimates the cost of additional sanitation, fire, and medical services due to events at the center to be approximately $0.2 million.

Required -

1. Would you agree with the council member that the arena was fiscally self-sustaining?

2. In which funds would the additional revenues and expenditures be budgeted and accounted for?

3. Comment on the limitations of both the traditional object classification budget and fund accounting system in assessing the economic costs and benefits of a project-such as the sports and special events arena.

4. What changes in the city's budgeting and accounting structure would overcome these limitations? What additional problems might these changes cause?