A capital projects fund in governmental accounting is a governmental fund used to account for financial resources that are restricted, committed, or assigned to major capital outlays, such as constructing public buildings, roads, or utilities, or acquiring other significant capital assets.1GASB. Statement No. 54 of the Governmental Accounting Standards Board It is temporary by design. The fund opens when financing arrives, tracks every dollar spent on the project, and closes once the asset is placed in service and every bill is paid.
The fund does not carry the finished asset on its books. A capital projects fund tracks the money moving through the project, not the courthouse or bridge that results from it. The completed asset appears elsewhere in the government’s reporting.
When a Government Sets One Up
A separate capital projects fund is not always required. GASB Statement No. 54 treats most governmental fund types as discretionary in certain circumstances, so a smaller capital acquisition could be run through the general fund.1GASB. Statement No. 54 of the Governmental Accounting Standards Board In practice, governments almost always establish a dedicated fund for major projects. Bond covenants, grant restrictions, and legislative appropriations demand segregated tracking, and running a $30 million bridge through the general ledger of everyday operations makes compliance nearly impossible to demonstrate.
Some capital spending stays out of a capital projects fund entirely. Capital acquisitions financed through a proprietary fund, such as a water utility’s enterprise fund, are recorded there. Assets held in trust follow their own fund structure.
Where the Money Comes From
Capital projects are usually too expensive to fund out of annual operating revenue. Financing tends to come from three sources, and how each is classified on the fund’s books matters.
Bond Proceeds
General obligation bonds and revenue bonds are the primary financing mechanism for large projects. When the cash from a bond sale arrives, the fund records it as an “other financing source” rather than as revenue. Revenue implies earned income; bond proceeds create a repayment obligation. Keeping them separate prevents the fund’s operating statement from overstating what the government actually earned.
Grants and Intergovernmental Revenue
Federal and state grants restricted to capital spending flow through the fund as revenue once eligibility requirements are met and the funds become measurable and available. Some grants are expenditure-driven, meaning the government spends first and draws down the grant later, which pushes recognition to the point when the qualifying expenditure occurs.
Interfund Transfers
When a government moves money from its general fund or another fund to cover part of the cost, the receiving capital projects fund reports it as an “other financing source,” not revenue. This preserves the distinction between money earned and money moved.
How Transactions Are Measured and Recorded
Capital projects funds use the current financial resources measurement focus with the modified accrual basis of accounting, the same combination used by every governmental fund.2GASB. Summary – Statement No. 34 That pairing shapes what appears on the fund’s statements and what does not.
The current financial resources focus limits the fund to cash and near-cash assets available for spending in the near term. Long-lived assets and long-term liabilities stay off the fund’s balance sheet. The building being constructed and the bonds financing it both live in the government-wide statements instead.
Under modified accrual, revenues are recognized when they are both measurable and available to pay current-period obligations.3National Center for Education Statistics. Financial Accounting for Local and State School Systems – Chapter 4: Governmental Accounting “Available” generally means collectible within the period or within 60 days after year-end.4GASB. Summary of Interpretation No. 5 Property taxes assessed for the project but not collectible within that window get recorded as deferred inflows rather than revenue.
Expenditures work differently. They are recognized when the related liability is incurred, not when cash goes out.5GASB. Summary of Interpretation No. 6 A contractor’s invoice becomes an expenditure the moment it is received and approved.
Encumbrances
Encumbrance accounting is where capital projects funds do some of their most useful work. When the government signs a construction contract or issues a purchase order, the committed amount is recorded as an encumbrance. Spending authority in the fund drops immediately, before any expenditure has occurred. The purpose is to keep officials from accidentally overcommitting by signing contracts that collectively exceed the budget.
When the contractor bills for work completed, the encumbrance is reversed and replaced with an actual expenditure. Final costs below the encumbered amount release the difference back to available authority. Costs above the encumbrance hit the fund as an additional expenditure.
Encumbrances outstanding at year-end do not vanish. Capital projects routinely span multiple years, and the commitments carry forward. Under GASB Statement No. 54, significant encumbrances are disclosed in the notes rather than shown as a separate line on the balance sheet, and encumbered amounts sit within whichever fund balance classification already applies to those resources.1GASB. Statement No. 54 of the Governmental Accounting Standards Board In a capital projects fund, that usually means restricted or committed.
Retainage
Public construction contracts commonly withhold a percentage of each progress payment, often 5 to 10 percent, until the project is substantially complete. The withheld amount sits on the fund’s balance sheet as a retainage payable. It protects the government if the contractor walks off the job or leaves defects. Once the final inspection is complete and any punch-list items are resolved, the retainage is released.
Interest During Construction
Interest costs incurred while a project is under construction are recognized as an expense in the period they are incurred and are not capitalized as part of the asset’s cost. GASB Statement No. 89 established that rule for governmental activities.6GASB. Summary – Statement No. 89 In the capital projects fund itself, the interest appears as an expenditure under modified accrual. It also does not fold into the building’s historical cost on the government-wide statements. The same treatment applies to enterprise funds.
Fund Balance Classifications
The fund balance on a capital projects fund balance sheet follows the hierarchy from GASB Statement No. 54.7GASB. Summary – Statement No. 54
- Restricted balances are limited to purposes dictated by external parties, constitutional provisions, or enabling legislation. Bond proceeds constrained by their covenants sit here.
- Committed balances are locked in by the government’s highest decision-making authority through a formal action like an ordinance or resolution, and unwinding the commitment requires the same level of action.
- Assigned balances reflect an intended purpose that lacks the formal constraint of restricted or committed resources. In governmental funds other than the general fund, this is whatever remains after restricted and committed amounts are accounted for.
- Unassigned appears in a capital projects fund only as a deficit, indicating overspending against amounts that were restricted, committed, or assigned.
Most capital projects fund balances end up classified as restricted or committed, because the money almost always arrives with strings attached.
Arbitrage Compliance on Tax-Exempt Bonds
When tax-exempt bonds finance the project, federal tax law limits how the government can invest the proceeds before spending them. Under 26 U.S.C. ยง 148, a bond loses its tax-exempt status if proceeds are invested in securities yielding more than the bond’s own yield, making it an “arbitrage bond.”8Office of the Law Revision Counsel. 26 USC 148 – Arbitrage Losing that status means bondholders suddenly owe federal income tax on their interest, the bonds become unmarketable, and future borrowing costs rise.
Even where higher-yielding temporary investments are permitted, the excess earnings generally must be rebated to the U.S. Treasury.9Internal Revenue Service. Complying with Arbitrage Requirements: A Guide for Issuers of Tax-Exempt Bonds (Publication 5271) Rebate payments are due at least every five years, each installment covering at least 90 percent of the cumulative arbitrage earnings owed at that point, with a final payment due within 60 days after the last bond in the issue is redeemed.8Office of the Law Revision Counsel. 26 USC 148 – Arbitrage
The IRS offers spending exceptions that let a government keep the earnings if proceeds are spent quickly enough. For capital projects, the most relevant is the two-year construction spending exception, available when at least 75 percent of the proceeds will go toward actual construction costs. Hitting the prescribed benchmarks within two years preserves all investment earnings. Missing any single benchmark disqualifies the entire exception with no catch-up provision, so a project that slips behind schedule carries real financial exposure. Tracking arbitrage runs for the full life of the bonds, not just the construction period, and the cost of a specialist consultant is a legitimate expenditure of the capital projects fund or debt service fund.
Closing the Fund
Once construction is complete, the asset is placed into service, and every final invoice and retainage payment clears, the capital projects fund closes. What happens to any leftover balance depends on the direction.
A positive balance, meaning the project came in under budget, typically transfers to the debt service fund to help pay down the bonds that financed the work. Bond covenants or the authorizing legislation usually dictate that destination. Depending on the restrictions on the original funding sources, the surplus may instead revert to the general fund or move to another capital project.
A negative balance is usually covered by a transfer from the general fund. That transfer eliminates the deficit so the capital projects fund can close at zero, and the fund is dissolved.
Reconciliation to the Government-Wide Statements
The fund’s statements tell one version of the story. The government-wide statements tell another. GASB Statement No. 34 requires a formal reconciliation between the two, and the differences are substantial.10GASB. Statement No. 34 of the Governmental Accounting Standards Board Government-wide statements use the economic resources measurement focus and full accrual accounting, so they report all assets and all liabilities regardless of when they will be collected or paid.2GASB. Summary – Statement No. 34
Three adjustments do most of the reconciling work. Capital outlay expenditures recorded in the fund are reclassified as long-term capital assets on the government-wide statement of net position. Bond proceeds that the fund reported as an “other financing source” are removed and replaced with a long-term liability. And once the asset is in service, the government-wide statements record depreciation expense to allocate its cost over its useful life.2GASB. Summary – Statement No. 34 Depreciation never appears in the capital projects fund itself, because the fund does not track long-lived assets.