12-1: Internal service funds

Effective: July 1, 1998
Revised: July 2, 2026
References: Utah Code 63J-1-410, Utah Code 63J-1-411, 2 CFR Appendix V to Part 200

Purpose

This policy explains how to manage internal service funds. It focuses on processes that must be consistent across the state, such as setting rates, managing working capital, and complying with federal rules.

Definitions

Internal service fund – A fund used to account for goods or services provided primarily to other state agencies on a cost-reimbursement basis.

Internal customers – State agencies, departments, and component units of the state (such as state colleges and universities) that receive goods or services from an internal service fund.

External customers – Entities outside of state government, including the public, private organizations, local governments, or other non-governmental parties.

GAAP – Generally accepted accounting principles.

GovOps – The Department of Government Operations.

Predominantly internal – A condition where the majority of an internal service fund’s activity, measured by revenue, usage, or cost, is provided to internal customers. Agencies should evaluate predominant participation using relevant operational indicators, including revenues, service utilization, cost allocation, and the nature of customers served.

Rate – The amount charged for a unit of service.

State finance – The GovOps Division of Finance.

Working capital (i.e., retained earnings, unrestricted fund balance, or unrestricted net position) – The accumulated financial resources available to support the day-to-day operations of an internal service fund. For this policy, agencies generally calculate working capital by starting with the fund’s ending balance and removing:

capital assets;
debt related to capital assets;
inventory;
prepaid expenses; and
other restricted or nonspendable amounts.

Working capital is used to evaluate whether internal service fund rates are recovering too much or too little over time and whether balances comply with federal reserve limits.

Policy

A – Internal service funds must primarily service internal customers

1 – Agencies must use internal service funds mainly to provide goods or services to internal customers.

2 – Agencies must look at the overall activity of the fund when deciding whether it mainly serves internal customers. This includes looking at who uses the services, why the services are provided, and how revenues relate to customer usage.

2a – The source of the revenue alone doesn’t determine whether activity is internal or external. Agencies must also consider who is using the services.

3 – An internal service fund may provide goods or services to external customers, but this external activity must not become its primary purpose.

B – Internal service funds must operate on a cost-recovery basis

1 – Agencies must operate their internal service funds as close to a break-even point as practical over time.

2 – Agencies must base their rates on the full cost of providing services, including direct costs, indirect costs, and allowable capital costs.

2a – Costs charged through internal service fund rates must be reasonable, allocable, consistently treated, and allowable under applicable federal requirements.

3 – Internal service fund rates must be documented, supportable, and applied consistently across users.

3a – To comply with federal requirements, agencies must keep clear records of finances, billing, utilization, service units, and cost allocations for their internal service funds. These records must fully support all rates, costs charged, and working capital calculations.

3b – Agencies must justify their rates using documented service units, utilization assumptions, cost allocation methods, and projected operating costs.

4 – Agencies must consider prior-year surpluses or deficits when setting future rates.

4a – When developing rates, agencies may use multi-year stabilization practices, as long as the rates remain justifiable and recover costs over time.

5 – Agencies must evaluate internal service funds’ financial performance by major service or activity to ensure rates don’t subsidize unrelated areas. Specifically, funds must not:

intentionally set rates for one service, activity, or customer group to subsidize another;
operate mainly to build unrestricted reserves or generate profits; and/or
finance activities unrelated to providing internal goods and services.

6 – Agencies must have legislative or statutory authorization before contributing or transferring cash and fixed assets between an internal service fund and another fund.

6a – Agencies may need to repay the federal share to the government if they transfer cash or resources from an internal service fund that has charged federally funded programs, as outlined in 2 CFR Appendix V to Part 200.

C – Agency rates must follow the state internal service fund rate process

1 – Agencies must develop internal service fund rates through the state’s official budget and rate process.

2 – Agencies may not charge a rate, fee, or other amount that has not been approved by the legislature.

2a – Agencies may establish and charge an interim rate, fee, or other amount without legislative approval for a new product or service if the new product is offered or service begins between annual general sessions of the Legislature.

3 – Agencies may charge a rate, fee, or other amount that is less than the approved amount if the agency provides written notification to the Governor’s Office of Planning and Budget and the Office of the Legislative Fiscal Analyst in accordance with 63J-1-410(5).

4 – Agencies must consider working capital and prior-year operating results when developing future rates.

5 – At least once a year, agencies must compare their billed revenues against actual costs and adjust future rates to make up for any differences.

6 – Agencies must make information readily available to understand how rates are calculated, what services are provided, and any significant rate changes.

D – Internal service funds must actively manage working capital

1 – Agencies must actively manage working capital in their internal service funds to ensure balances are sufficient for operations without accumulating excessive working capital beyond operational needs.

1b – Agencies may maintain planned reserves for future capital replacement, system implementation, or other long-term operational needs if supported by documented plans, reasonable cost estimates, and applicable federal requirements.

2 – Agencies must monitor working capital during the annual budget and rate setting process.

2a – Agencies must develop corrective actions when operating results or working capital show ongoing structural surpluses or deficits.

3 – Short-term deficits or cash shortages aren’t always compliance failures, provided the agency has a written plan to stabilize its finances by adjusting future rates or operations.

4 – When developing corrective plans, agencies must choose long-term rate adjustments and operational changes over temporary, one-time solutions.

E – Agencies must follow federal working capital requirements

1 – Agencies that charge federally funded programs through internal service funds must comply with 2 CFR Appendix V to Part 200.

2 – Working capital funded by federal programs must not exceed 60 days’ worth of regular operating cash expenses.

2a – Cash expenses must exclude noncash costs, such as depreciation and amortization and any other expenses that don’t require current cash outlays.

3 – Agencies must calculate allowable working capital every year by determining 60 days of regular operating cash expenses and comparing that amount to actual working capital. Agencies must document the calculation and keep supporting documentation.

3a – Agencies must document any adjustments made to their reported working capital balances to show exactly how they calculated the operating amounts.

4 – When actual working capital balances exceed allowable working capital, agencies must take corrective action by adjusting future rates, issuing credits, providing rebates, or returning the federal share as required.

4a – Agencies must work with state finance on any corrective actions and include these adjustments when setting future rates.

F – Agencies must follow borrowing and repayment requirements

1 – To finance working capital and buy fixed assets, internal service funds must use funding sources in this order:

Operating revenues and accumulated working capital (as allowed by law and federal rules).
Authorized borrowing from other funds.
Appropriations or transfers from other funds.

2 – Internal service funds may only borrow from the General Fund or other approved sources. At the end of the fiscal year, agency borrowing must not exceed 90% of the net book value of the internal service fund’s capital assets.

2a – For the purposes of this policy, negative cash balances in an internal service fund will be treated as borrowing from the General Fund, even if no formal loan agreement exists.

2b – Agencies must monitor negative cash balances and include those amounts when evaluating compliance with borrowing limits and repayment requirements.

3 – Agencies must have a clear repayment plan in place before borrowing any funds.

3a – As required by law, agencies must repay long-term borrowing from the general fund or special revenue funds used to purchase capital assets. This repayment must be made through regular payments that span the useful life of the assets and align with their depreciation schedules.

4 – Agencies must only use interfund borrowing to support capital asset purchases or to cover short-term cash flow needs, not to fund ongoing losses. Agencies must fix operating deficits by using one of the following methods:

rate adjustments;
operational changes;
appropriations; or
another corrective action plan approved by the legislature and state finance.

5 – When borrowing to buy capital assets, agencies should generally structure repayment over the asset’s useful life. Agencies may recover these costs through depreciation included in rates, appropriations, or other approved funding sources.

6 – Agencies must monitor their debt balances and consider repayment obligations when developing future rates for their internal service funds.

G – Agencies must review internal service fund classification

1 – Agencies must periodically review whether an internal service fund classification still makes sense for their operations. This review should be based on 4 key areas:

the types of services provided;
the kind of customers being served;
the sources of funding used; and
current financial practices.

2 – Agencies must evaluate internal service funds on how they actually operate rather than just how they’re statutorily created. This review must look at the fund’s customer base, funding sources, rate structures, reserve practices, and operational purpose.

3 – Agencies must work with state finance before expanding services to external customers to determine if their existing fund classification is still appropriate.

4 – If an internal service fund’s activity no longer focuses primarily on internal customers and/or on a cost-reimbursement basis, the agency must work with state finance to determine if a different fund classification is appropriate (such as enterprise fund, special revenue fund, etc.) for financial reporting purposes and whether legislative changes to the fund’s statutory classification should be considered.

H – State finance may review internal service funds

1 – State finance may review internal service fund operations, rates, and working capital calculations.

2 – Agencies must provide documentation and corrective plans when requested.

3 – State finance may review an internal service fund’s classification, rates, reserves, customer base, or operational structure when circumstances indicate the fund may no longer meet the definition of an internal service fund.

3a – If state finance determines that a fund no longer meets the GAAP definition of an internal service fund, State Finance may report the fund as a different fund type in the State’s Annual Comprehensive Financial Report (ACFR).

3b – Reporting a fund as a different fund type in the ACFR does not change the fund’s statutory classification or budgetary treatment.

3c – Legislative approval is required to change a fund’s statutory classification.