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Chapter 3: Financial Audit
Government-Wide and Fund Financial Statements
The government-wide financial statements, which are the statement of
net assets and the statement of activities, report information of all of the
nonfiduciary activities of the department. Governmental activities,
normally supported by state allotments and intergovernmental revenues,
are reported separately from business-type activities, which rely to a
significant extent on fees and charges for support. For the most part, the
effect of interfund activity has been removed from these government-
wide financial statements.
The statement of activities demonstrates the degree to which the direct
expenses of a given function are offset by program revenues. Direct
expenses are those that are clearly identifiable with a specific function.
Program revenues include charges to customers who purchase, use, or
directly benefit from goods or services provided by a given function.
Program revenues also include grants and contributions that are
restricted to meeting the operational or capital requirements of a
particular function. State allotments and other items not properly
included among program revenues are reported instead as general
revenues. Resources that are dedicated internally are reported as general
revenues rather than program revenues.
Net assets are restricted when constraints placed on them are either
externally imposed or imposed by constitutional provisions or enabling
legislation. Internally imposed designations of resources are not
presented as restricted net assets. When both restricted and unrestricted
resources are available for use, it is generally the department’s policy to
use restricted resources first, then unrestricted resources as they are
needed.
Separate financial statements are provided for governmental funds,
proprietary funds, and fiduciary funds. However, the fiduciary funds are

not included in the government-wide financial statements. Major
individual governmental funds and major individual enterprise funds are
reported as separate columns in the fund financial statements.
Measurement Focus, Basis of Accounting, and Financial
Statement Presentation
Government-wide Financial Statements – The government-wide
financial statements are reported using the economic resources
measurement focus and the accrual basis of accounting. Revenues are
recorded when earned and expenses are recorded when a liability is
incurred, regardless of the timing of the related cash flows. Grants and
similar items are recognized as revenue as soon as all eligibility
requirements imposed by the provider have been met.
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Chapter 3: Financial Audit
Governmental Fund Financial Statements – The governmental fund
financial statements are reported using the current financial resources
measurement focus and the modified accrual basis of accounting.
Revenues are recognized as soon as they are both measurable and
available. Revenues are considered to be available when they are
collectible within the current period or soon enough thereafter to pay
liabilities of the current period. For this purpose, the department
considers revenues to be available if they are collected within 60 days of
the end of the current fiscal year-end. Principal revenue sources
considered susceptible to accrual include federal grants and interest on
investments. Some revenue items that are considered measurable and
available to finance operations during the year from an accounting
perspective are not available for expenditure due to the State’s present
appropriation system. These revenues have been accrued in accordance

with GAAP, since they have been earned and are expected to be
collected within 60 days of the end of the period. Other revenues are
considered to be measurable and available only when cash is received by
the department.
Expenditures generally are recorded when a liability is incurred, as under
accrual accounting. Modifications to the accrual basis of accounting
include accrued vacation and workers’ compensation liability, which is
recorded as an expenditure when due and payable.
Proprietary Funds and Fiduciary Funds – The financial statements of
proprietary funds and fiduciary funds are reported using the economic
resources measurement focus and the accrual basis of accounting, similar
to the government-wide financial statements described above.
In accordance with GASB Statement No. 20, Accounting and Financial
Reporting for Proprietary Funds and Other Governmental Entities That
Use Proprietary Fund Accounting, the department has elected not to
apply all Financial Accounting Standards Board (FASB)
pronouncements issued after November 30, 1989, unless FASB conflicts
with GASB.
Proprietary funds distinguish operating revenues and expenses from
nonoperating items. Operating revenues and expenses generally result
from providing services or goods in connection with a proprietary fund’s
principal ongoing operations. Revenues and expenses not meeting this
definition are reported as nonoperating revenues and expenses. The
principal operating revenues of the department’s enterprise funds are
interest income and administrative loan fees on loans made to county
governments. Federal grants, state matching funds, and interest income
from investments are reported as nonoperating income.
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Chapter 3: Financial Audit
Fund Accounting
The financial activities of the department are recorded in individual
funds, each of which is deemed to be a separate accounting entity. The
department uses fund accounting to report on its financial position and
results of operations. Fund accounting is designed to demonstrate the
legal compliance and to aid financial management by segregating
transactions related to certain government functions or activities. A fund
is a separate accounting entity with a self-balancing set of accounts.
The financial activities of the department that are reported in the
accompanying fund financial statements have been classified into the
following major and nonmajor governmental and proprietary funds. In
addition, a description of the department’s fiduciary fund is as follows:
Governmental Fund Types
The department reports the following major governmental funds:
General Fund
This fund is the department’s primary operating fund. It accounts for
all financial activities of the department, except those required to be
accounted for in another fund. The annual operating budget as
authorized by the State Legislature provides the basic framework
within which the resources and obligations of the general fund are
accounted.
Tobacco Settlement Fund
This fund accounts for all tobacco settlement moneys and interest
and earnings accruing from the investment of such moneys.
The nonmajor governmental funds are comprised of the following:
Special Revenue Funds
These funds account for the financial resources obtained from
specific revenue sources (other than major capital projects) that are
legally restricted to expenditures for specified purposes.

Capital Projects Fund
This fund accounts for financial resources to be used for the
acquisition or construction of major capital facilities (other than
those financed by proprietary funds).
Proprietary Fund Type – Enterprise Funds
The major enterprise funds are comprised of the following:
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Chapter 3: Financial Audit
Water Pollution Control Revolving Fund
This fund accounts for federal and state funds used to provide loans
in perpetuity to county and state agencies for the construction of
wastewater treatment facilities and the repayment, interest and
earnings from such loans, and the investment of such moneys.
Drinking Water Treatment Revolving Loan Fund
This fund accounts for federal and state funds used to provide loans
and other types of financial assistance to public water systems for
drinking water infrastructure and the repayment, interest and
earnings from such loans, and the investment of such moneys.
Fiduciary Fund Type
Agency Fund
This fund accounts for assets held by the department in an agency
capacity.
Capital Assets
Capital assets, which includes property and equipment, are reported in
the applicable governmental or business-type activities in the
government-wide financial statements and in the proprietary fund
financial statements. Capital assets are defined by the department as
those assets with estimated useful lives greater than one year and with an

acquisition cost greater than:
Land All capitalized
Land improvements $100,000
Building and building improvements 100,000
Equipment 5,000
Purchased and constructed capital assets are valued at cost. Donated
assets are recorded at their fair market value at the date of donation.
Capital outlays for items utilized in the governmental funds are recorded
as expenditures when incurred in the governmental fund financial
statements.
The costs of normal maintenance and repairs that do not add to the value
of the asset or materially extend asset lives are not capitalized.
Depreciation expense is recorded in the government-wide financial
statements, as well as the proprietary fund financial statements. The
department utilizes the straight-line method over the assets’ estimated
useful life. No depreciation is recorded for land. Generally, the useful
lives are as follows:
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Chapter 3: Financial Audit
Governmental Business-type
Activities Activities
Land improvements 15 Not applicable
Building and building improvements 30 Not applicable
Furniture and equipment 5 – 7 5 - 7
Cash and Cash Equivalents
Cash and cash equivalents include short-term investments with original
maturities of three months or less. It also includes amounts held in the
state treasury. The state director of finance is responsible for

safekeeping of all moneys paid into the state treasury (cash pool). The
state director of finance may invest any moneys of the State, which in the
director’s judgment are in excess of the amounts necessary for meeting
the immediate requirements of the State. Cash is pooled with funds from
other state agencies and departments and deposited into approved
financial institutions or invested in the State Treasury Investment Pool
System. Cash accounts that participate in the investment pool accrue
interest based on the average weighted cash balances of each account.
The State requires that the depository banks pledge, as collateral,
government securities held in the name of the State for deposits not
covered by federal deposit insurance.
Investments can be categorized to give an indication of the level of
custodial credit risk assumed by the department. Category 1 includes
investments that are insured or for repurchase agreements, collateralized
by underlying securities that are so held. Category 2 includes uninsured
and unregistered investments for which the securities are held by the
broker-dealer in the department’s name. Category 3 includes uninsured
and unregistered investments for which the securities are held by the
broker-dealer but not in the department’s name.
Since all of the department’s cash is included in the state cash pool, the
category of custodial credit risk is not determinable at the department
level.
Deferred Revenues
Deferred revenues at the fund level and government-wide level arise
when the department receives resources before it has a legal claim to
them. In subsequent periods, when the revenue recognition criteria is
met, or when the department has a legal claim to the resources, the
liability for deferred revenue is removed from the statement of net assets
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Chapter 3: Financial Audit
or balance sheet and revenue is recognized. Deferred revenues at
June 30, 2003 consist primarily of federal grant funds for which all
eligibility requirements have not been met.
Compensated Absences
Employees hired on or before July 1, 2001 earn vacation at the rate of
one and three-quarters working days for each month of service.
Employees hired after July 1, 2001 earn vacation at rates ranging
between 1 and 2 working days for each month of service, depending
upon the employees’ years of service and job classification. Vacation
days may be accumulated to a maximum of 90 days each calendar year.
Employees are entitled to receive cash payment for accumulated vacation
upon termination. Accumulated vacation is not reported in the
governmental fund financial statements until it is due and payable, as
that amount is otherwise not expected to be paid with current funds. The
government-wide financial statements present the cost of accumulated
unpaid vacation as a liability. A reconciliation of changes in aggregate
liabilities for accumulated vacation is as follows:
Governmental Activities
Balance at July 1, 2002 $ 17,852,053
Additions 9,967,618
Deletions (9,316,052)
Balance at June 30, 2003 18,503,619
Less current portion (6,661,303)
$ 11,842,316
Employees hired on or before July 1, 2001 also earn sick leave credits at
the rate of one and three-quarters working days for each month of
service. Employees hired after July 1, 2001 earn sick leave credits at the
rate of one and one-quarter or one and three-quarters working days for

each month of service, depending upon the employees’ years of service
and job classification. Sick leave credits may be accumulated without
limit. Sick leave can be taken only in the event of illness, and is not
convertible to pay upon termination of employment. Accordingly, no
liability for unpaid sick leave credits is reported in the accompanying
basic financial statements. However, a department employee who retires
or leaves government service in good standing with 60 days or more of
unused sick leave is entitled to additional service credit in the
Employees’ Retirement System of the State of Hawaii. Accumulated
sick leave as of June 30, 2003, relating to the department approximated
$57,263,000.
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Chapter 3: Financial Audit
Insurance
Insurance coverage is maintained at the state level. The State is
substantially self-insured for all perils including workers’ compensation.
Expenditures for workers’ compensation and other insurance claims are
appropriated annually from the state general fund.
Under the provisions of GASB Statement 10, liabilities related to certain
types of losses (including torts, theft of, damage to, or destruction of
assets, errors or omissions, natural disasters, and injuries to employees)
are reported when it is probable that the losses have occurred and the
amount of those losses can be reasonably estimated.
During the year ended June 30, 2003, the department was covered by the
State’s self-insured workers’ compensation program for medical
expenses of the injured department employees. However, the department
was required to pay Temporary Total Disability (TTD) and Temporary
Partial Disability (TPD) benefits for employees on the department’s

payroll. Claims expenditures and liabilities are reported when it is
probable that a loss has occurred and the amount of that loss can be
reasonably estimated. Liabilities include an amount for claims that have
been incurred but not reported. Because actual claims liabilities depend
on such complex factors as inflation, changes in legal doctrines, and
damage awards, the process used in computing claims liability does not
necessarily result in an exact amount. Claims liabilities are reevaluated
periodically to take into consideration recently settled claims, the
frequency of claims, and other economic and social factors.
The department paid $679,000 for workers’ compensation claims during
the year. A reconciliation of changes in the department’s workers’
compensation liability is as follows:
Balance at July 1, 2002 $ —
Current year claims 1,313,373
Claim payments (679,000)
Balance at June 30, 2003 $ 634,373
Transfers
Transfers are used to move revenues from the fund that statutes require
to collect them to the fund that statute requires to expend them. The
government-wide statement of activities eliminates transfers within the
segregated governmental and business-type activities.
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Chapter 3: Financial Audit
Receivables and Payables
Activities between funds that are representative of lending/borrowing
arrangements outstanding at the end of the fiscal year are referred to as
interfund receivables/interfund payables. Any residual balances
outstanding between the governmental activities and the business-type

activities are reported in the government-wide financial statements as
internal balances.
Use of Estimates
In preparing basic financial statements in conformity with GAAP,
management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Nonimposed Employee Fringe Benefits
Payroll fringe benefit costs of the department’s employees are funded by
general fund appropriations and are assumed by the State, accordingly,
such costs are not charged to the department’s operating funds. These
costs, totaling $30,535,685, of which $7,334,000 was for retirement
benefits, have been reported as revenues and expenditures in the
department’s basic financial statements for the fiscal year ended June 30,
2003.
Payroll fringe benefit costs related to federally funded salaries are not
assumed by the State and are recorded as expenditures in the
department’s basic financial statements.
Revenue estimates are provided to the State Legislature at the time of
budget consideration and are revised and updated throughout the fiscal
year. Budgeted expenditures are derived primarily from acts of the State
Legislature and from other authorizations contained in the State
Constitution, the Hawaii Revised Statutes (HRS) and other
authorizations contained in other specific appropriation acts in various
Session Laws of Hawaii. To the extent not expended or encumbered,
general fund appropriations generally lapse at the end of the year for
which the appropriations were made. The State Legislature specifies the
lapse date and any other particular conditions relating to terminating the

authorization for other appropriations.
For budgeting purposes, the department’s budgetary fund structure and
accounting principles differ from those utilized to present the basic
financial statements in conformity with GAAP. Encumbrances represent
Note 2 – Budgeting and
Budgetary Control
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Chapter 3: Financial Audit
executed but unperformed purchase orders or contracts. Encumbrances
are recorded as expenditures for budgetary purposes and as reservations
of fund balance for GAAP purposes. Since budgetary basis differs from
GAAP, budget and actual amounts in the accompanying Required
Supplementary Information – Budgetary Comparison Schedules are
presented on the budgetary basis. A reconciliation of the excess of
revenues over expenditures on a budgetary basis to the excess
(deficiency) of revenues over expenditures presented in conformity with
GAAP is set forth in the Note to Budgetary Comparison Schedules.
At June 30, 2003, the proprietary fund loans receivable consists of loans
to county governmental units for the water pollution control and drinking
water treatment programs. The loans are due in annual, semi-annual, or
quarterly payments, including interest at 1.55 percent to 3.02 percent,
commencing not later than one year after project completion or notice to
proceed. Final payment is due not later than 20 years after project
completion. Accrued interest receivable on the loans amounted to
approximately $1,555,825 at June 30, 2003.
The following is a schedule of principal payments due on loans for
projects completed or in progress as of June 30, 2003:
Year ending June 30:

2004 $ 11,233,023
2005 11,525,840
2006 11,807,261
2007 12,098,068
2008 12,396,571
Thereafter 114,618,713
$ 173,679,476
Note 3 – Loans
Receivable
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Chapter 3: Financial Audit
Capital asset activity for the year ended June 30, 2003 was as follows:
Depreciation expense for the year ended June 30, 2003 was charged to
functions as follows:
Governmental activities
General administration $ 513,091
Environmental health 1,632,877
Behavioral health 1,598,868
Health resources 861,649
Total depreciation expense – governmental activities $ 4,606,485
Business-type activities:
Environmental health $ 73,434
Note 4 – Capital Assets
Beginning Ending
Balance Additions Deletions Balance
Governmental activities:
Capital assets not being depreciated:
Land $ 1,018,080 $ — $ — $ 1,018,080

Total capital assets not being depreciated 1,018,080 — — 1,018,080
Capital assets being depreciated:
Land improvements 1,862,927 — — 1,862,927
Building and improvements 126,113,479 — (276,000) 125,837,479
Furniture and equipment 12,298,031 930,456 (1,029,979) 12,198,508
Total capital assets being depreciated 140,274,437 930,456 (1,305,979) 139,898,914
Less accumulated depreciation:
Land improvements 1,475,755 115,023 — 1,590,778
Building and improvements 52,718,719 3,892,465 (276,000) 56,335,184
Furniture and equipment 10,515,309 598,997 (1,012,970) 10,101,336
Total accumulated depreciation 64,709,783 4,606,485 (1,288,970) 68,027,298
Total capital assets of governmental activities, net $ 76,582,734 $ (3,676,029) $ (17,009) $ 72,889,696
Business-type activities:
Capital assets being depreciated:
Equipment $ 459,907 $ 179,743 $ (46,188) $ 593,462
Less accumulated depreciation for equipment 214,667 73,434 (46,188) 241,913
Total capital assets of business-type activities, net $ 245,240 $ 106,309 $ — $ 351,549
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Chapter 3: Financial Audit
Employees’ Retirement System
Plan Description
All eligible employees of the State are required by Chapter 88, HRS, to
become members of the Employees’ Retirement System of the State of
Hawaii (ERS), a cost-sharing multiple-employer public employee
retirement plan. The ERS provides retirement benefits as well as death
and disability benefits. The ERS issues a comprehensive annual
financial report that is available to the public. That report may be
obtained by writing to the ERS at 201 Merchant Street, Suite 1400,

Honolulu, Hawaii 96813.
The ERS consists of a contributory plan and a noncontributory plan.
Employees covered by Social Security on June 30, 1984 were given the
option of joining the noncontributory plan or remaining in the
contributory plan. All new employees hired after June 30, 1984, who are
covered by Social Security, are generally required to join the
noncontributory plan. Both plans provide a monthly retirement
allowance based on the employee’s age, years of credited service, and
average final compensation (AFC). The AFC is the average salary
earned during the five highest paid years of service, including the
payment of salary in lieu of vacation, if the employee became a member
prior to January 1, 1971. The AFC for members hired on or after this
date is based on the three highest paid years of service excluding the
payment of salary in lieu of vacation. Vesting requirements for the
contributory and noncontributory plans are five years and ten years,
respectively. All contributions, benefits, and eligibility requirements are
governed by Chapter 88, HRS.
Funding Policy
Most covered employees of the contributory plan are required to
contribute 7.8 percent of their salary. Police officers, firefighters,
investigators of the department of the prosecuting attorney and the
attorney general, narcotics enforcement investigators, and public safety
investigators are required to contribute 12.2 percent of their salary. The
actuarial cost or funding method used to calculate the total employer
contribution required is the entry age normal actuarial cost method.
Under this method, the total employer contributions to the ERS is
comprised of normal cost plus level annual payments required to
amortize the unfunded actuarial accrued liability over the closed period
ending June 30, 2029.
Post-Retirement Health Care and Life Insurance Benefits

In addition to providing pension benefits, the State provides certain
health care and life insurance benefits to all employees hired prior to
July 1, 1996 who retire from State employment on or after attaining age
62 with at least ten years of service or age 55 with at least 30 years of
Note 5 – Retirement
Benefits
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