FAR · Financial reporting · 9 practice questions
Enterprise vs Internal Service: 'Payable Solely' and Rollup
Use an enterprise fund only when charging external users and a GASB trigger applies; otherwise it is optional. Below: a decision tree to classify the fund and the government-wide rollup.
Try one first
Hint
First decide whether the primary customers are external or internal; then consider whether debt is payable from net revenues or there is an intent to recover costs through user charges.
Answer C. The activity meets enterprise fund criteria because it is intended to be financed primarily through user charges and its revenue bonds are payable solely from the utility's net revenues. Under GASB guidance, enterprise funds are reported as business-type activities in the government-wide statements. Incidental billings to city departments do not change the primary classification when external customers and user-charge cost recovery predominate.
Why not A: This distractor appeals to the fact that city departments receive service, which is a feature of internal service funds. It fails because internal service funds are appropriate only when the activity primarily serves other government departments; here external customers are the principal users and the financing characteristics support an enterprise fund reported as business-type activity.
Why not B: This is tempting because government ownership may appear to imply governmental activity, but classification depends on the nature of financing and the primary customers rather than ownership alone. The presence of user-charge financing and revenue-backed debt indicates business-type activity, so the government-wide presentation should be business-type.
Why not D: This choice mixes elements that seem to support business-type reporting (user charges and revenue-backed debt) with an internal service fund classification. It misleads by implying the fund type can be internal despite external customers predominating. Because external customers and revenue-backed debt exist, the correct fund is an enterprise fund, which maps to business-type activity.
Decide it in order
T1Are external customers the primary customers of the activity?
T2Is any enterprise trigger met: (a) debt payable solely from the activity’s net revenues; (b) law or external regulation requires total cost recovery through fees; or (c) a formally adopted pricing policy to recover total costs, including capital?
YesReport in an enterprise fund; in the government-wide statements, present as business‑type activities.NoEnterprise fund reporting is permitted but not required; absent that election, report the activity in a governmental fund and exclude it from business‑type activities.T3Does the activity primarily serve the government’s own departments (internal service), and do the predominant beneficiaries fall within governmental activities rather than enterprise funds?
YesReport in an internal service fund; in the government-wide statements, present with governmental activities.NoReport in an internal service fund; in the government-wide statements, present with business‑type activities because enterprise funds are the predominant users.
Key points
- Debt payable solely from the activity’s net revenues requires enterprise fund reporting even if fees do not cover all costs or the General Fund subsidizes operations.
- Incidental internal billings do not change an enterprise classification when external customers and user‑charge financing predominate.
- If revenue debt also carries a full‑faith‑and‑credit pledge, the debt is not payable solely from the activity’s revenues, so enterprise reporting is not required (it may still be elected).
- Internal service funds are proprietary at the fund level but roll into governmental activities in the government-wide statements unless they predominantly serve enterprise funds, in which case they roll into business‑type activities.
- Government-wide reporting for internal service funds is not split proportionally; it follows the predominant users as a group.
How the exam traps you
- Classifying an activity as enterprise solely because fees are charged or expected to cover costs. Check for a mandatory trigger. Without it, enterprise reporting is optional only if external customers are primary; otherwise use an internal service or governmental fund as appropriate.
- Ignoring a sole‑revenue‑pledge and leaving the activity in a governmental fund because fees do not cover all costs. A pledge making debt payable solely from the activity’s net revenues requires enterprise fund reporting regardless of subsidies or partial cost recovery.
- Rolling internal service funds into governmental activities by default even when they predominantly serve enterprise funds. Identify the predominant users. If enterprise funds receive the majority of services, roll the internal service fund into business‑type activities.
- Treating organizational placement or public benefit as the driver of fund type. Base classification on customer base and GASB triggers, not department labels or perceived public benefit.
Question 2
Hint
Classify each activity separately. For the road program, focus on the nature and continuing significance of the restricted revenue source; for the motor pool, focus on who primarily receives the services.
Answer A. The gasoline-tax distribution should be accounted for in a special revenue fund because it is a specific revenue source legally restricted to a particular program (routine road maintenance) and is expected to be a continuing, substantial inflow for that program (not for debt service or capital projects). The motor pool is an internal service fund because it provides goods and services primarily to the government's own departments on a cost-reimbursement basis (85% internal), even though it has some external customers.
Why not B: This is tempting because the motor pool has some outside customers, but an enterprise fund is appropriate only when an activity is financed primarily through charges to external users. Here the motor pool serves county departments predominantly (85%), so it is an internal service fund rather than an enterprise fund.
Why not C: A capital projects fund would be used for financing capital outlays. The stem specifies the gasoline-tax distribution is restricted to routine road maintenance and explicitly excludes capital construction, so a capital projects fund is not appropriate.
Why not D: The general fund would be used if the revenue were unrestricted or not dedicated to a specific program. Because the gasoline-tax distribution is legally restricted to the road maintenance program and is expected to be a substantial recurring source, a special revenue fund is the correct classification.
Question 3
Hint
First decide whether the activity belongs in a governmental fund or a proprietary fund. Then ask whether the construction purpose changes that answer.
Answer D. The marina is a business-type activity serving external users and the ordinance requires fees to recover operating and capital costs, so proprietary fund reporting is appropriate. An enterprise fund (a proprietary fund) is used for such fee-supported activities. Capital projects funds are governmental funds and are not used to account for capital assets and related construction when the activity is reported in a proprietary fund.
Why not A: Tempting because the grant is restricted for construction. However, capital projects funds account for governmental capital projects financed with governmental fund resources; capital assets and related construction for business-type activities reported in proprietary funds belong in the proprietary fund (enterprise fund).
Why not B: Tempting because the activity charges fees intended to recover costs, but internal service funds are used when services are provided primarily to other governmental departments or agencies, not to the general public; that points to an enterprise fund instead.
Why not C: Tempting because the grant is restricted, but special revenue funds are for specific revenue sources restricted or committed for purposes other than capital projects and debt service within governmental funds. Here the restriction funds a capital facility tied to a fee-supported, business-type activity.
Question 4
Hint
Focus on the GASB conditions that make enterprise fund reporting mandatory, and decide which fact would override the city's policy choices about pricing or subsidies.
Answer D. Under current GASB guidance, meeting the debt-pledge condition requires enterprise fund reporting: if an activity's debt is secured solely by a pledge of the activity's net revenues from fees and charges, the activity should be reported in an enterprise fund. Here the bonds are payable only from airport net revenues and bondholders lack a claim on taxing power, so that mandatory criterion is met. The city's temporary pricing choices or anticipated tax-supported transfers do not negate the debt-pledge requirement.
Why not A: This is tempting because GASB also treats pricing policies designed to recover all costs as a criterion for enterprise funds. However, in this fact pattern a separate mandatory trigger (debt secured solely by net revenues) already applies, so the pricing-intent issue is not the governing factor.
Why not B: Although airports serve a public purpose, GASB fund-type classification depends on specific criteria (debt pledge, legal requirement, or pricing policy), not on the general public-benefit character of the activity.
Why not C: Candidates often assume expected tax support implies governmental-fund reporting, but anticipated or occasional tax-supported transfers do not override a mandatory enterprise-fund criterion when the activity's debt is pledged solely to its own net revenues.
Question 5
Hint
Focus on which facts GASB treats as mandatory enterprise-fund triggers, not on facts that are merely common in fee-based government activities.
Answer C. GASB identifies specific triggers that require enterprise-fund reporting. One mandatory trigger is when debt for the activity is secured solely by a pledge of the net revenues or fees of that activity (for example, revenue bonds payable only from parking fees). That fact alone requires enterprise-fund treatment. By contrast, charging fees generally is common for enterprises but, absent a legal or policy requirement or the debt-secured-by-fees trigger, it does not by itself mandate an enterprise fund.
Why not A: Transfers from the general fund indicate subsidy or support but do not by themselves create the mandatory enterprise-fund reporting trigger. The GASB requirement focuses on specific legal or financing triggers (such as debt secured solely by pledged revenues).
Why not B: Organizational placement (being a department of public works) does not determine fund type. GASB looks to how the activity is financed and whether specific triggers for enterprise funds are met, not the department that manages it.
Why not D: While charging fees to external users is typical for enterprise activities, fees alone, especially given the stem's assumption that no law or pricing policy requires cost recovery, do not automatically require enterprise-fund reporting without a triggering condition such as debt secured solely by the activity's fees.
Question 6
Hint
First decide whether the activity mainly serves outside parties or the government's own departments. Then decide where that fund's balances usually appear in the government-wide statements.
Answer B. An internal service fund accounts for goods or services provided primarily to other departments of the same government on a cost-reimbursement basis. Because the motor pool serves departments accounted for in governmental funds and does not materially serve the public or enterprise funds, classify it as an internal service fund. At the government-wide level, internal service funds that predominantly benefit governmental functions are reported within governmental activities.
Why not A: Although the motor pool charges fees, enterprise funds are for activities that provide services to external users or are operated like business-type activities for the public. Because this pool's customers are internal governmental departments and it does not serve the public or enterprises, an enterprise fund is inappropriate.
Why not C: The general fund is not intended to separately track a centralized cost-recovery operation. A separate internal service fund better captures the motor pool's charge-for-service financing and allocation of operating and replacement costs.
Why not D: This choice correctly identifies the fund type but misstates government-wide presentation: internal service funds are generally reported in governmental activities when their primary beneficiaries are governmental functions, regardless of whether they are financed by charges.
Question 7
Hint
Focus on whether the service is provided mainly to the public or mainly to the government's own departments.
Answer D. An internal service fund reports activities that provide goods or services primarily to other departments or agencies of the same government, usually on a cost-reimbursement basis. The program here bills city departments and serves them almost exclusively, which fits internal service fund reporting. An enterprise fund, by contrast, is used when services are provided to external users or the general public.
Why not A: The general fund is the default operating fund, but centralized service activities that mainly serve the government's own departments and charge them for services are typically reported in an internal service fund rather than the general fund.
Why not B: Enterprise funds are fee-for-service funds, so candidates may be tempted by the billing aspect; however, enterprise funds are appropriate when the activity serves external users or the public, not primarily other governmental departments.
Why not C: Special revenue funds track resources restricted or committed to particular governmental activities. They are not designed for centralized internal cost-reimbursement service operations like a maintenance and fuel program.
Question 8
Hint
Focus on the main user of the service, then ask whether any of the clearer enterprise-fund triggers are actually present.
Answer A. The controlling consideration is whether the activity primarily provides goods or services to the government's own departments; if so, an internal service fund is appropriate. Here 87% of billings are to the city's departments, so the activity is predominantly internal. Other enterprise-fund indicators are absent: no debt secured by revenues, no legal requirement to charge fees, and rates are not intended to recover capital costs. Incidental external billings (13%) do not override the predominance of internal service.
Why not B: Enterprise funds are often fee-supported, but charging fees does not by itself require enterprise classification; internal service funds commonly charge departments on a cost-reimbursement basis. The key is who the primary customers are, not merely whether fees are charged.
Why not C: Billing external customers is relevant but not decisive, if external billing is incidental (13% here) and the activity primarily serves the government's departments, the internal service classification still applies. Enterprise treatment typically requires that the activity be primarily financed by user charges to the public or meet other enterprise triggers.
Why not D: Setting rates to recover current operating costs describes cost-recovery pricing but does not determine fund type. Enterprise funds often recover capital and operating costs and may have revenue-backed debt or legal fee requirements; those enterprise triggers are absent here.
Question 9
Hint
Identify the fund type first, then ask whether the usual government-wide treatment has an exception when one activity category is the clear primary user.
Answer D. Internal service funds are proprietary at the fund level, but in the government-wide statements they are generally reported with the activity they predominantly support. The usual default is to include internal service funds in governmental activities, but when an internal service fund predominantly provides services to enterprise (business-type) funds it is reported with business-type activities. Because about 78% of the IT unit's services go to enterprise funds, it should be reported in business-type activities.
Why not A: This is tempting because the typical default is to include internal service funds with governmental activities. However, the stem states the fund predominantly serves enterprise funds (78%), which triggers the exception to report it with business-type activities.
Why not B: While internal service funds are not shown as a separate column in the government-wide statements, they are not omitted. Their net position and results are incorporated into either governmental or business-type activities depending on which they predominantly support.
Why not C: Proportional allocation sounds precise, but government-wide presentation does not normally split an internal service fund each year between the two activity columns. Instead, the fund is included with the activity category it predominantly serves.
Common questions
Does an enterprise fund require full cost recovery through fees?
No. Enterprise reporting is required if any trigger is met, including debt payable solely from the activity’s net revenues. Fees may be below cost and subsidies may occur.
If an internal service fund mainly serves enterprise funds, where is it reported in the government-wide statements?
With business‑type activities. Internal service funds follow the group that predominantly benefits; they are not proportionally allocated.
Is serving external users alone enough to require an enterprise fund?
No. Serving external users permits enterprise reporting, but it becomes mandatory only if a GASB trigger is met (sole‑revenue debt, legal/external cost‑recovery requirement, or a formal total‑cost pricing policy).
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