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Debt Service Funds
Chapter 8
Learning Objectives for DSFs
Understand basic purpose and nature of DSFs and liabilities serviced by them
Understand when DSFs are required and when other funds may be used
Understand when expenditures on GLTL are recognized
Understand when governments may accrue principal and interest expenditures before maturity
Record transactions and prepare financial statements
Understand accounting and reporting for special assessment DSFs
Understand requirements for GLTL term bonds and deep discount debt
Understand, record, & report refundings of GLTL
Purpose of DSFs
To account for the accumulation of resources for, and the payment of, general long-term debt principal and interest
Required only if
Legally mandated, or
Financial resources are being accumulated for principal and interest payments in future years
Debt Terminology
General obligation indicates “full faith and credit” of the governmental unit pledged to repay the debt
Revenue debt indicates specific revenue source dedicated to repay the debt
Double barrel is revenue debt with repayment guaranteed by full faith and credit of governmental unit
Types of Long-Term Liabilities
Bonds
Notes
Time Warrants
Capital Leases (including leases, lease-
purchase agreements, certificates of
participation, and installment purchase
contracts)
Bonds
Usually issued in $1,000 or $5,000
denominations
Maturity runs from 15 to 25 years
Interest paid annually or semi-annually
Types
Serial – the most widely used, principal comes due in
installments
Term – principal comes due at a single point in time
Notes
Typically less formal than bonds
May be
Short-term – 30 to 90 days – reported as fund
liabilities
Long-term – 3 to 5 years – reported in GLTL
Single note used for entire transaction
rather than multiple bonds
Warrants
Notes – multiple year warrants that are the same as notes payable
Checks Check warrant
Promises to pay
Money must be in bank on date it comes due
Reported in GLTL if maturity date is more than 1 year in future
“Normal check” Order to pay
Money must be in bank on date written
Capital Leases, et. al.
Instruments have widespread use in public
sector
Certificates of participation (CoPs) divide
leases into shares that are sold to
investors
Some leases made with deep discounts –
little or no interest paid during term
Other Bond Terms
Interest rates
Fixed – most common – aids in planning for expenditures
Variable – more flexibility
Debt service payments – try to minimize fluctuations
Fiscal agents – process interest and principal payments
Other Bond Terms (continued)
Funded reserves
Highest year’s principal and interest
Give bondholders additional assurance of prompt
payments
Bond ratings – aid in determining interest rates
and reserves
Bond insurance – helps lower interest rates and
reserves; may assist is issuance of bonds
Other Bond Terms (continued)
Sources of financing to repay bonds – property taxes, sales taxes, or first revenues accruing to treasury
Investments – excess funds invested until needed; must keep arbitrage in mind
Expenditure recognition – usual classifications Interest
Principal
Fiscal agent fees
Typical Debt Service Transactions
Budgetary entry
Receipt of financing
Investments
Debt service expenditures
#1 Budgetary entry [Page 308]
Estimated Revenues – Property Taxes
Estimated Revenues – Investment
Income
Estimated Transfer from GF
Appropriations – Bond Principal
Retirement
Appropriations – Interest on Bonds
Appropriations – Fiscal Agent Fees
Unreserved Fund Balance
162,000
6,000
80,000
100,000
50,000
10,000
88,000
#2 Financing operations [Page 308]
Cash
OFS – Transfer from GF
80,000
80,000
#3 Make investments to establish
funded reserves [Page 308]
Investments
Unreserved Fund Balance
Cash
Reserve for Fiscal Exigencies
80,000
80,000
80,000
80,000
#4 Record taxes [Page 308]
Taxes Receivable – Current
Allowance for Uncollectible
Current Taxes
Revenues – Property Taxes
165,000
3,000
162,000
#5 Collect taxes [Page 308]
Cash
Taxes Receivable – Current
158,000
158,000
#6 Record investment earnings [Page 308]
Cash
Revenues – Investment Income
4,000
4,000
#7 Record debt service expenditures[Page 309]
Expenditures – Debt Service –
Principal
Expenditures – Debt Service – Interest
Expenditures – Debt Service – Fiscal
Agent Fees
Matured Bonds Payable
Matured Interest Payable
Fiscal Agent Fees Payable
100,000
50,000
10,000
100,000
50,000
10,000
GCA GLTL NA– =
– $100,000 $100,000
#8 Payment of fund liabilities [Page 309]
Matured Bonds Payable
Matured Interest Payable
Fiscal Agent Fees Payable
Cash
100,000
50,000
10,000
160,000
#8 Debt Service Expenditures:
Alternate Approach [Not in textbook]
Cash with Fiscal Agent
Cash
Matured Bonds Payable
Matured Interest Payable
Matured Fiscal Agent Fees Payable
Cash with Fiscal Agent
160,000
100,000
50,000
10,000
160,000
160,000
First entry made to transfer funds to fiscal agent. Second entry occurs when
fiscal agent makes actual payments. Transactions may be in different fiscal
years – common when payables are accrued for payment early in next fiscal
year.
Special Assessment DSFs
Capital improvement financed by local government
LTD used to finance construction
Special assessments pay principal and interest on bond issue
Government plays two roles:General contractor to oversee project
Financing agent to provide interim financing and repayment of debt
#1 Levy special assessments [Page 312]
Assessments Receivable – Deferred
Deferred Revenues – Assessments
800,000
800,000
#2 Assessments become current[Page 313]
Assessment Receivable – Current
Assessments Receivable – Deferred
Deferred Revenues – Assessments
Revenues – Assessments
200,000
200,000
200,000
200,000
#3 Transfer from GF [Page 313]
General Fund
OFS – Transfer to SA DSF
Cash
Special Assessment DSF
Cash
OFS – Transfer from GF
260,000
260,000
260,000
260,000
#4 Payment of principal &
interest on SA debt [Page 313]
Expenditures – Debt Service – Principal
Expenditures – Debt Service – Interest
Cash
200,000
60,000
260,000
#5 Special assessment collections[Page 313]
Cash
Assessments Receivable – Current
Revenues – Interest
240,000
185,000
55,000
#6 Receivables reclassified [Page 313]
Assessments Receivable – Delinquent
Accrued Interest Receivable
Assessments Receivable – Current
Revenues – Interest
Deferred Revenues – Interest
15,000
5,000
15,000
3,500
1,500
Other DSF Issues
Interest not accrued at year-end unless
Resources for payment have been received by year-end, and
Payment is due within first month of next fiscal year
Combining financial statements prepared as other information when more than one DSF is reported
Term Bond Issues
Accumulation of required funded reserves
Annual payment of interest and fiscal
charges
Systematic accumulation of sinking fund to
retire bonds at maturity
Retirement of Bonds
Points in Time
Before maturity
At maturity
After maturity
Known as default
Want to avoid this
event!
Sources of Funding
Existing resources
New bond issues
Means of retiring bonds early
Callable bonds
Provision in outstanding bonds to retire bonds
early
Typically pay a premium to call bonds in
addition to accrued interest and principal
Refunding – using new bonds to substitute
for old bonds
Reasons for advance refunding
Lower effective interest rates
Extend maturity dates
Revise payment schedules
Remove or modify restrictions
GASB Defines “Refunding”
Issuing new debt whose proceeds are used to repay previously issued (“old”) debt
Current refunding – new debt proceeds used to repay old debt immediately
Advance refunding – new debt proceeds placed with escrow agent and invested until used to pay old debt principal and interest in the future
Refunding Process
Debtor
Refunding (New)
Debt Issue
Investor
Refunded (Old)
Debt Issue
Bank or Other Trust
Department or Agency
Proceeds invested in irrevocable trust
to service Old Debt Issue
Proceeds of New Debt Issue
Retired Old Debt Securities
CURRENT REFUNDINGS
ADVANCE REFUNDINGS
Proceeds
of New
Debt Issue
Debt Service
Payments on Old
Debt Issue (over
remaining term
or until call date*
* Debt securities are eventually retired and returned to the debtor
Defeasance
Debt that has been defeased is considered to be extinguished, is removed from the GLTL accounts, and is not reported in the balance sheet
Conventional defeasance is the normal retirement of debt
Advance refunding defeasance occurs when old debt remains outstanding but proceeds from new debt are in irrevocable trust and service old debt until retired
Types of Defeasances
Legal – bond covenant of old debt includes
defeasance provisions
In-substance – bond covenant of old debt does
not include defeasance provisions, but doesn’t
disallow the refunding
Nondefeasance – old debt and new debt both
stay on the books when proper actions are not
taken in defeasance process
Defeasance:
Source of Funding vs. Reporting
Issue Refunding Bonds [Page 324]
Cash
Expenditures – Debt Service – Bond
Issue Costs
OFS – Refunding Bond Principal
OFS – Refunding Bond Premium
2,005,000
15,000
2,000,000
20,000
GCA GLTL NA– =
$2,020,000 – $2,005,000$15,000
Retirement of old bonds [Page 324]
OFU – Retirement of Refunded
Term Bonds
Cash
2,000,000
2,000,000
GCA GLTL NA– =
– $2,000,000 $2,000,000
Advance Refunding – issuance of
refunding bonds [Page 325]
Cash
Expenditures – Debt Service – Bond
Issue Costs
OFS – Refunding Bond Discount
OFS – Refunding Bond Principal
1,900,000
15,000
85,000
2,000,000
GCA GLTL NA– =
$1,915,000 – $1,900,000$15,000
Defeasance of old bonds [Page 325]
OFU – Payment to Refunded Bond
Escrow Agent
Cash
1,900,000
1,900,000
GCA GLTL NA– =
– $2,000,000 $2,000,000
Advance Refunding:
Debt and Non-debt Financing [Page 326]
Cash
Expenditures – Debt Service – Bond
Issue Costs
OFS – Transfer from GF
OFS – Refunding Bond Principal
OFS – Refunding Bond Premium
1,300,000
10,000
300,000
1,000,000
10,000
GCA GLTL NA– =
$1,010,000 – $1,000,000$10,000
Advance Refunding:
Defeasance of old bonds [Page 326]
Expenditures – Debt Service –
Payment to Refunded Bond
Escrow Agent
OFU – Payment to Refunded Bond
Escrow Agent
CashAssumes DSF had $600,000 in existing resources
900,000
1,000,000
1,900,000
GCA GLTL NA– =
– $2,000,000 $2,000,000
Advance Refunding Disclosures:
Year of Refunding
General description of transaction
Difference in cash flows of debt service
requirements for old debt and for new debt
Economic gain or loss (present value of
difference in cash flows)
Advance Refunding Disclosures:
Subsequent Years
Legal Defeasance – no subsequent
disclosures required
In-Substance Defeasance – amount of
defeased debt still outstanding until all
bonds are retired
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