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Municipal Budget Planning: Surplus & Deficit

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The terms “surplus” and “deficit” are commonly used, but can be understood from an accounting perspective. By the end of this document you will be better able to: 

  • Differentiate between a municipality’s annual budget, annual financial statements and long-term financial plans as they relate to asset management. 
  • Understand the concepts of surplus and deficit from an accounting perspective and in the context of municipal budgeting and financial planning.

While carefully prepared, this document is a summary and does not take into account differing local circumstances.  The laws and practices referred to are subject to change. Accordingly, the document, as well as any links or information from other sources referred to in it, should not be relied upon, including as a substitute for specialized legal, accounting or other professional advice in connection with any particular matter. Municipalities and other users are responsible for any use or application of the document. 

ANNUAL MUNICIPAL BUDGET PLANNING

The budgeting process allows municipalities to prioritize projects, programs and service levels based on anticipated revenue and expenses. A municipality’s annual budget routinely consists of two components:
The operating budget plans for a municipality’s day-to-day expenditures (e.g. salaries, wages, benefits, heat, hydro and maintenance of buildings and infrastructure). 
The capital budget plans for the purchase and financing of assets or improvement of existing infrastructure (e.g. libraries, storm sewers, recreation centres, parks and roads).

MUNICIPAL ACCOUNTING METHODS 

There are different types of accounting methods that can be used for budgeting and financial reporting.

Accrual accounting

Accrual accounting involves recording revenues as they are earned during the fiscal period, regardless of when they are collected. Expenses are recorded when the liability for the expense is initially incurred. 
In this method, the municipality’s tangible capital assets are expensed in regular installments over a period of time. This is referred to as “amortization.” In general, this period of time corresponds to the useful life of the asset. 

Modified accrual accounting

This form of municipal accounting is accrual accounting with the adjustments permitted by Ontario Regulation (O. Reg.) 284/09 (for more information, readers may wish to refer to the tip sheet on Ontario Regulation 284/09 developed by the Municipal Finance Officers’ Association, the regulation, or the Municipal Act.

The regulation states a municipality may exclude certain expenses from the budgeted amount, including:

  • Amortization expenses
  • Post-employment benefits expenses
  • Solid waste landfill closure and post-closure expenses

Most municipalities plan their budget using a modified accrual basis budget. Certain rules may apply to municipalities using this method.

ACCRUAL VS MODIFIED ACCRUAL ACCOUNTING

This chart shows how a municipality’s consolidated statement of operations (income statement) changes according to the method selected. This example compares the accrual and modified accrual accounting. 

Accrual Basis

 

Modified Accrual Basis

 

Revenues

 

Revenues

 

Taxation

User fees

1,425,000

775,000

Taxation

User fees

1,425,000

775,000

Government grants

325,000

Government grants

325,000

Investment income

15,000

Investment income

15,000

Other revenues

40,000

Other revenues

40,000

 

 

Transfers from Reserves (1)

176,000

 

 

Proceeds from debt (1)

200,000

Total Revenues

2,580,000

Total Revenues

2,956,000

 

Expenses

 

 

Expenditures

 

Compensation and benefits

1,500,000

Compensation and benefits

1,500,000

Materials and supplies

300,000

Materials and supplies

300,000

Contractual services

200,000

Contractual services

200,000

Other goods and services

106,000

Other goods and services

106,000

Interest expense

20,000

Interest expense

20,000

 

 

Principal repayments (2)

125,000

 

 

Transfers to Reserves (2)

5,000

Amortization

400,000

Capital expenditures

700,000

Total Expenses

2,526,000

Total Expenditures

2,956,000

Accrual Surplus (3)

54,000

Modified Accrual Surplus

0


 


1 Under the modified accrual basis, these transfers and/or other funding sources might be considered somewhat similar to revenue, in that proceeds or a transferred amount (or part of it) might offset or affect the amounts a municipality decides to raise in a year.

2 Under modified accrual basis, these transfers (repayment amounts) might be considered as somewhat similar to expenses, in that a transferred amount (or part of it) might affect the amounts a municipality decides to raise in a year.

3 Under the accrual method of accounting, transfers are neither revenues nor expenses. Only the interest portion of debt repayments are expenses, not the principal amount, and capital expenditures are capitalized and amortized (i.e. expensed) over an asset’s useful life.  In this example, the accrual surplus of $54,000 is the difference between total revenues and total expenses; it consists of transfers from reserves, proceeds from debt less principal repayments, transfers to reserves and capital expenditures, plus amortization expense. Represented mathematically: ($-176,000-$200,000) + [($125,000+$5,000+$700,000) + ($400,000)] = $54,000.

BUDGETS, FINANCIAL STATEMENTS & LONG-TERM FINANCIAL PLANNING

Budgets are “forward-looking” documents. They report a municipality’s planned revenue and the cost of public services for an annual or multi-year period. 

Financial statements are “backward-looking” documents. They report on the actual resources used by the municipalities and the full cost of the services delivered to the public in that year. The Municipal Act requires that municipalities prepare their financial statements using accrual accounting, in accordance with Public Sector Accounting Board (PSAB) standards. For more information, refer to section 294.1 of the Municipal Act and other sections in the legislation.

A municipality’s financial statements at the end of the year may differ from their original budget for a number of reasons:

  • Since a municipality usually prepares a modified accrual budget the initial estimates in a modified accrual budget will be different from the actual financial results at the end of the fiscal year (see the chart on page 3 for an example). 
  • The difference between the estimated and actual expenses will either result in a surplus or deficit for budgeting purposes. Unplanned events — like a natural disaster or unusually heavy snowfalls — might require a municipality to spend money that it may not have planned for in the budget, resulting in a financial statement deficit. 

Municipalities can use the budget to help control spending and identify revenues to support its long-term financial plan. 

Long-term financial planning considers a municipality’s long-term costs and investments over a multi-year period. A long-term plan considers the costs of inflation and may include items such as funding for service enhancements, the replacement costs of existing assets, and development of new infrastructure. These long term financial plans could be for a period of 10, 20 or even 50 years. 

UNDERSTANDING SURPLUS AND DEFICIT

In a municipal budget, the annual calculation for surplus/deficit of the previous year shows whether the planned revenues for the previous year were enough to cover the planned expenses (cash outlays).  Any differences are to be carried forward into the budget year period as revenue (surplus) or expense (deficit) in accordance with the rules in the legislation. Please refer to section 289 of Municipal Act, 2001 and other sections of the legislation for more information.

In a financial statement, the annual surplus/deficit shows whether the revenues generated were greater than the expenses incurred, including non-cash expenses such as amortization.

Surplus and deficit in a financial statement do not necessarily indicate performance. As examples:

  • A surplus does not mean that a municipality has extra funds to spend. It could mean that a municipality that has funds reserved for future obligations such as paying retirement benefits. 
  • A deficit could be the result of an unexpected emergency, or the reporting of amortization expense. 

When calculating the annual surplus/deficit, the costs of using capital assets over the lives of the assets is recognized — meaning a portion of the asset’s cost is charged as an amortization cost each year, until the asset is considered to be fully paid off.

If a municipality were to operate with a significant deficit over several years and planned to continue this practice, it would likely face major financial repercussions. 

The problem would likely emerge when an existing major asset failed, for example. Council would be pressured to choose between increasing tax rates, borrowing large sums of money (not always possible), and/or not replacing the asset, and risking social and economic consequences in the community.

To get a better picture of their financial state, municipalities may wish to monitor or enhance monitoring of their gross debt, net debt positions, and use of cash. 

Accumulated surplus occurs when all of a municipality’s assets (financial and non-financial), exceed all its liabilities. This means that a municipality may have excess assets (financial and non-financial) that can be used to provide future services. 

Accumulated deficit means that a municipality’s liabilities exceed their assets. This could mean that a municipality financed annual operating deficits by borrowing large sums of money. 

SUMMARY

  • Most municipalities plan their budget on a modified accrual basis – which may be described as accrual budgeting with the adjustments permitted by Ontario Regulation 284/09.
  • Budgeting can help municipalities to manage spending and identify revenue to support their long-term financial plan.
  • Budgets are “forward looking” and plan for the future, while financial statements are “backwards looking” and report on what happened.
  • An annual financial statement deficit means that revenue is less than expenses, while accumulated deficit means that liabilities exceed total assets (financial and non-financial). 
  • An annual financial statement surplus means that revenues are greater than expenses, while accumulated surplus means that total assets (financial and non-financial) exceed liabilities.