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