What Are Proprietary Funds?

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Proprietary funds are used to account for business-like activities in local government.

These funds are used when a local government is either:

  • Providing services to the public and charging residents for them
  • Providing services to internal customers and reimbursing itself for them
 

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Types of Proprietary Funds: Enterprise Funds and Internal Service Funds

There are two types of proprietary funds:

  • Enterprise Funds. These funds account for services provided to the general public, like utilities. Enterprise funds are paid for through user charges.
  • Internal Service Funds. These funds account for internal operations, such as services provided by a government’s centralized vehicle fleet management department provided to all other departments. Internal service funds are paid for through reimbursements.

Let’s look closer at these two types of proprietary funds.

Enterprise Funds

Enterprise funds account for activities that are self-sustaining, collecting revenue in the form of fees for services. 

Self-sustainability is a key characteristic of an enterprise fund. These funds are designed to account for financially independent services that cover their operating expenses and capital costs primarily through user fees.

Common examples of enterprise funds include: 

  • Water and sewer utilities
  • Public transportation
  • Public parking facilities

Internal service funds

On the other hand, internal service funds account for work done by internal services within the government, collecting revenue by charging other departments for their services, which means they work on a cost-recovery basis. Using this framework helps drive efficiency and reduce waste in the services provided.

Cost recovery is a key characteristic of an internal service fund.  These funds recover costs by charging other departments for the services they provide.

Common examples of internal service funds include: 

  • Fleet management services 
  • IT support
  • Insurance services
  • Maintenance departments

Examples of Proprietary Funds

Let’s look at a few real-world examples of these two types of proprietary funds to make things more concrete.

Enterprise Fund Examples

Example 1—City Water System

Consider a water system that services residents.

Funded through its enterprise fund, administrators provide regular services. The water system pays for these services by charging residents for their use, bringing in revenue to fund the ongoing work.

Example 2—Ice Skating Rink

Imagine an ice skating rink run by a local government.

To operate the ice rink, the city will have a proprietary Ice Rink fund devoted to it, which will be used exclusively for the rink’s revenue and expenses. 

The fund will gather revenue in the form of payments made by residents, and expenses for the rink will be paid out from that fund. The Ice Rink fund will be completely separate from other funds the city has—the Ice Rink can’t receive tax dollars, and other city initiatives can’t be paid for from it.

Internal Service Fund Examples

Example 1—Fleet Management 

Consider a fleet of vehicles used for transportation and work by local government employees.

By optimizing its internal service fund, a city might improve the efficiency of its fleet management, leading to cost savings for other municipal departments. This example highlights the benefits of effective internal service fund management.

Example 2—Information Technology (IT) Services

Imagine the IT services that support the work of local government.

To run the IT team, a devoted internal service fund is used to provide technology support and services, which are provided to various municipal departments. 

Each department is charged based on their usage or the IT services they receive, effectively reimbursing the IT Service Fund for the expenses incurred in providing these services.

A Closer Look at Enterprise Funds

The examples above help us get a basic understanding of how enterprise and internal service funds operate.

But in reality, several enterprise funds may contribute to a single operation.

Here are the enterprise funds that account for sewer operations in the City of York, PA:

  • Sewer—Fund 60. This is a city fund for the collection of sewer fees and the operation and maintenance of Sewer Maintenance.  
  • Debt Service Sewer Revenue Bonds. This is a funding source for various capital improvements paid for by sewer revenue and the connected municipalities. 
  • Intermunicipal Sewer Fund—Fund 61. This is for the operation and maintenance of the Wastewater Treatment Plant
  • Sewer Transportation—Fund 62. This fund holds moneys for the $.0.04 per 1,000 gallons charged to the connected municipalities for use to pay for capital improvements to the sanitary sewer conveyance system and/or the Wastewater Treatment Plant.

Looking at revenue by type for these funds, here is actual data from the City of York:

proprietary-funds-city-of-york-example

Dig deeper into this real-world example from the City of York, PA. 

In 2021, someone broke into the City of York’s offices and destroyed their server. But the City’s budget data wasn’t destroyed because City leaders had moved it to the cloud.

York, PA (ERP)

"If it had not been for OpenGov, I'm not sure when we would have gotten the budget done."

Thomas Ray, Business Administrator, City of York, PA

Types of Local Government Funds: Placing Proprietary Funds in Context

In addition to proprietary funds, governments typically use two other types of funds to manage their financial resources effectively. 

Here are the three primary types of funds used in local government.

1. Governmental Funds

These funds encompass all those used for traditional government functions that are not intended to be business-like (as opposed to proprietary funds, which are intended to be business-like). 

Governmental funds are funded primarily through tax revenue, charges for services, and fines. There are several types of governmental funds, including: 

  • General funds
  • Special revenue funds
  • Capital project funds
  • Debt service funds
  • Permanent funds.

2. Fiduciary Funds

These funds are used for assets that the government holds as a trustee or agent for individuals, private organizations, or other government units. Fiduciary funds are funded primarily through resources that the government holds in a trustee or agent capacity for others.

3. Proprietary Funds

As we’ve covered, these funds operate more like private businesses and are intended to be self-supporting, primarily through user fees and charges. Proprietary funds are funded through user fees and charges (i.e., reimbursements).

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Four Key Distinctions of Proprietary Funds

So how are proprietary funds distinct from fiduciary funds and all the specific types of governmental funds we shared above?

In this section, we’ll look at four main ways proprietary funds are unique: key aspects, accounting, financial statements, and the roles they play in local government.

1. Key Organizational Aspects of Proprietary Funds

Here are some key aspects of proprietary funds:

  • Revenue generation. Unlike traditional government funds, which rely on tax revenues, proprietary funds generate income through service fees (or through reimbursement, in the case of internal service funds).
  • Business-like operations. Both enterprise and internal  service proprietary funds mimic private sector business practices, focusing on efficiency and cost recovery.
  • Types of services. Proprietary funds commonly cover utilities like water and electricity, public transportation, and internal services such as vehicle maintenance.

2. Accounting for Proprietary Funds

Distinguishing proprietary funds from governmental funds is vital in understanding public sector accounting.

The main differences between proprietary funds and other types of governmental funds can be found in their objectives and accounting methods:

  • Financial objectives. While proprietary funds aim for financial self-sufficiency, governmental funds are primarily concerned with providing services to the public, regardless of revenue generation.
  • Accounting method. Proprietary funds use accrual accounting, similar to private businesses, where revenues and expenses are recorded when they are incurred. In contrast, governmental funds use modified accrual accounting, focusing on the availability of financial resources.

3. Financial Statements for Proprietary Funds

Important financial statements for proprietary funds are:

  • Statement of net position. It shows the fund’s assets, liabilities, and net position, giving an insight into its financial health.
  • Statement of changes in fund net position. This statement details changes made to operating revenues and expenses, highlighting changes in the fund’s financial position over the fiscal year.

4. The Roles Proprietary Funds Play in Local Government Finance 

Proprietary funds play a crucial role in local government finance, helping manage services that are more commercial in nature but also contributing to the overall financial stability of government entities.

Here are the three main roles these funds play:

  • Financial independence. These funds help certain activities within the government to operate without relying on tax revenues, thereby reducing the financial burden on the general fund.
  • User-fee funding. User fee funds allow for the direct linking of service costs to service users, promoting accountability, and efficiency.
  • Support for CIP. Proprietary funds can accumulate funds for significant capital projects, which are crucial for maintaining and upgrading essential public services.

 

FAQs on Proprietary Funds: Addressing Common Questions and Misconceptions

Here are some frequently asked questions about proprietary funds to help provide more clarity on what they are and how they’re used in local government.

Do proprietary funds generate profit?

It’s a common misconception that these funds are designed to generate profits. In reality, their primary goal is cost recovery, with the main goal of ensuring that the services these funds pay for are reliable and financially sustainable.

Can proprietary funds borrow money or issue bonds?

Proprietary funds have the ability to borrow money and issue bonds, especially for significant capital projects. This financial flexibility is crucial for large-scale improvements and expansions.

How are service rates determined for proprietary funds?

Setting rates for services provided by proprietary funds involves a careful balance. Rates must cover the costs of service provision, including operational expenses and future capital needs, while remaining fair and affordable for users.

The Future of Proprietary Funds: Three Trends to Watch

Here are some emerging trends and predictions shaping the future of proprietary funds.

1. Technology and Innovation

The integration of new technology is expected to streamline operations, enhance service delivery, and improve financial management for business-like entities run by proprietary funds. 

Improvements could include things like the adoption of smart metering for utilities, automated billing systems, and data analytics for better decision-making.

2. Focus on Sustainability

As environmental concerns grow, proprietary funds are likely to emphasize sustainability in their operations. 

This might involve investing in renewable energy sources for public utilities or adopting eco-friendly practices in transportation services.

3. Expanded Service Offerings

Proprietary funds may broaden to cover a wider range of services, such as community broadband networks or electric vehicle charging stations, reflecting changing public needs and technological advancements.