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Debt Service Funds. Chapter 8. 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
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Debt Service Funds Chapter 8
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 Learning Objectives for DSFs
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
GCA – GLTL = NA #7 Record debt service expenditures[Page 309] – $100,000 $100,000
#8 Debt Service Expenditures:Alternate Approach [Not in textbook] 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
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
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 Retirement of Bonds
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
CURRENT REFUNDINGS Debtor Proceeds of New Debt Issue Investor Refunding (New) Debt Issue Refunded (Old) Debt Issue Retired Old Debt Securities ADVANCE REFUNDINGS Debt Service Payments on Old Debt Issue (over remaining term or until call date* Proceeds of New Debt Issue Bank or Other Trust Department or Agency Proceeds invested in irrevocable trust to service Old Debt Issue * Debt securities are eventually retired and returned to the debtor Refunding Process
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
GCA – GLTL = NA Issue Refunding Bonds [Page 324] $15,000 $2,020,000 – $2,005,000
GCA – GLTL = NA Retirement of old bonds [Page 324] – $2,000,000 $2,000,000
GCA – GLTL = NA Advance Refunding – issuance of refunding bonds [Page 325] $15,000 $1,915,000 – $1,900,000
GCA – GLTL = NA Defeasance of old bonds [Page 325] – $2,000,000 $2,000,000
GCA – GLTL = NA Advance Refunding:Debt and Non-debt Financing [Page 326] $10,000 $1,010,000 – $1,000,000
GCA – GLTL = NA Advance Refunding:Defeasance of old bonds [Page 326] – $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
