Module 2

1
Module 2

• Government Business-type Funds Chapters 6-9

2
Chapter 6

• Accounting for Capital Projects Debt Service

3
Fund Purpose

• Capital project debt service funds are
  governmental funds used for specific purposes.
• The purpose of capital project funds is to
  acquire use the resources dedicated to acquire
  or build specific capital projects (e.g.,
  buildings, roads, etc.).
• Debt service funds are used to acquire use
  financial resources to pay interest principal
  on long-term debt associated with the
  governmental funds.
• Both funds use modified accrual accounting.

4
Characteristics of Capital Project Funds (CPFs)

• Capital projects are generally funded using
  long-term municipal (tax exempt) debt to fund
  capital projects.
• Debt covenants usually require resources to be
  used exclusively for the specific capital
  projects funded.
• Capital projects usually are budgeted through
  capital budgets may not require annual budget
  entries (this varies from one government to
  another). The primary reason for budget entries
  is for control.

5
Basic Journal EntriesCapital Project Funds

• Budget entry (if necessary), 50,000 from bonds
  for construction Estimated Bond Proceeds
  50,000 Appropriations 50,000
• Issuance of Bond Cash 50,000 Bond
  Proceeds (other financing sources) 50,000

6
Basic Journal EntriesCapital Project Funds (2)

• Signing of construction contract for
  50,000 Encumbrances 50,000 Reserve for
  Encumbrances 50,000
• Construction is completed contractor paid
  50,000 Reserve for Encumbrances
  50,000 Encumbrances 50,000 ExpendituresCons
  truction 50,000 Cash 50,000

7
Basic Journal EntriesCapital Project Funds (3)

• Closing entries Appropriations 50,000 Es
  timated Bond Proceeds 50,000 Bond
  Proceeds 50,000 Expenditures-Construction
  50,000

8
Other CPF Issues

• Bond Premiums Discounts issue costs.
• Bond premiums are usually recorded as other
  financing sources transferred to debt service
  funds (note a multiple fund entry).
• Other sources of funding including grants,
  transfers from other funds, investment earnings.

9
Characteristics of Debt Service Funds (DSFs)

• Debt service funds primarily service the
  long-term debt associated with acquiring capital
  assets in CPFs.
• Cash is usually transferred in from the general
  fund (or other fund). Other possible resources
  include taxes payable specifically to the DSF
  investment earnings,
• Interest is most often paid semi-annually
• Many of the bonds are serial bonds, where some
  amount of principal is repaid annually.
• Also, long-term notes capital leases.
• Interest principal are recognized as current
  liabilities in the DSF in the period they must be
  paid.

10
Basic Journal EntriesDebt Service Funds

• Nonreciprocal transfer from the general fund
  (note a multi-fund transaction) for the payment
  of interest, 10,000 Cash 10,000 Transfe
  rs In (other financing
  sources) 10,000
• Payment of interest, 10,000
• Expenditures-Interest 10,000 Matured
  Interest Payable 10,000 Matured Interest
  Payable 10,000 Cash 10,000
• Closing entry Transfers In 10,000 Exp
  enditures-Interest 10,000

11
Basic Journal EntriesDebt Service Funds (2)

• Nonreciprocal transfer from the general fund
  (note a multi-fund transaction) for the payment
  of interest, 10,000, principal,
  160,000 Cash 170,000 Transfers In
  (other financing sources) 170,000
• Payment of interest principal,
  170,000 Expenditures-Interest
  10,000 Expenditures-Principal 160,000 Mature
  d Interest Payable 10,000 Matured Bonds
  Payable 160,000 Matured Interest Payable
  10,000 Matured Bonds Payable 160,000
  Cash 170,000
• Closing entry Transfers In 170,000 Ex
  penditures-Interest 10,000 Expenditures-Prin
  cipal 160,000

12
Other DSF Issues

• Budget entries can be used.
• Transfer in of premium on bonds from a DSF (an
  other financing source recorded as a
  nonreciprocal transfer).
• Investing cash in investments recognizing
  revenues from investments.
• Recognizing tax revenues (the same process as
  with the General Fund).

13
Government-wide Statements

• Full accrual includes all assets liabilities
• Construction costs are accumulated as
  construction in progress capitalized in the
  financial statements.
• Debt Service principal payments reduce
  liabilities interest is an expense ( is
  accrued).

14
Special Assessments

• This is usually associated with construction
  projects associated with specific property owners
  (e.g., to build sidewalks), with construction
  costs charged to these property owners as special
  assessments (either with one lump payment or over
  time).
• The construction activity would be accounted for
  in a CPF.
• If the government is obligated for the debt
  (which is usually the case), the debt is paid
  through a DSF. If the government is not
  obligated (that is, the property owners are
  obligated), the debt is serviced in an agency
  fund.

15
Debt Refunding

• Governments can retire debt before maturity
  (e.g., using callable bonds).
• When governments retire debt early replace it
  with new debt, this is called bond refunding.
  Major reasons include lower interest rates on new
  debt, changing the maturity structure,
  eliminating certain restrictive covenants.
• In-substance defeasance an advance refunding
  when the borrowing satisfies the obligations
  economically, but not legally (e.g., placing
  required funding in trust or escrow). Costs
  benefits would normally be recorded in a DSF.

16
Chapter 7

• Long-lived Assets Investments in Marketable
  Securities

17
General Capital Assets

• General capital assets (essentially property,
  plant equipment) are not-financial associated
  with the government as a whole.
• Since they are non-financial, they are not
  accounted for in specific funds (which have a
  financial resources focus).
• Capital assets include land, buildings,
  equipment, improvements other than buildings,
  construction in progress infrastructure assets
  (e.g., roads bridges).

18
Accounting for General Capital Assets

• Acquisition or construction of capital assets is
  recorded as an expenditures in a governmental
  fund (e.g., capital projects fund). The asset is
  not capitalized. Trade-in transactions are
  reported as expenditures at their net of
  trade-in cost.
• Governments must maintain records of capital
  assets.
• Government-wide reporting reported at historical
  costs less accumulated depreciation, plus notes
  with additional information.

19
Should Governments Report on Infrastructure
Assets?

• Controversial issue historically, governments
  could choose whether or not to accounting for
  infrastructure assets. GASB emphasizes the
  importance of cost of services.
• Traditional approach (GASB 34) expenditures in
  governmental funds capitalize the costs record
  depreciation in the government-wide statements.
• Modified approach (government-wide statements)
  capitalize but do not record depreciation
  instead, expense preservation costs (which extend
  the useful life of the assets).
• Importance of maintenance governments must
  disclose maintenance costs for a 5-year period
  comparisons of required maintenance to maintain a
  specific condition.

20
Impairment of Capital Assets

• An asset is impaired if its service utility has
  declined significantly.
• Governments should test for impairment (GASB 42),
  using one of three methods 1. Restoration
  cost approach (cost to restore asset
  utility). 2. Service-units approach (
  decline in service units). 3.
  Deflated depreciation replacement cost
  approach (estimate new carry value).

21
Investments in Marketable Securities

• Governments invest in stocks, bonds other
  marketable securities, primarily because they can
  accumulate large amounts of cashtax collections,
  bond proceeds before construction is completed
  paid for, etc. Pensions endowments will be
  discussed later.
• Investments can include repurchase agreements
  (usually with broker-dealers derivatives.
  Governments can use resource pools (e.g., managed
  by the state).
• Investments are recorded at fair value
  investment
• income includes changes in fair value.
• According to GASB 40, governments must disclose
  information on risks credit risks of investments
  (e.g., bond ratings), investments concentration
  (greater than 5 of total investments), interest
  rate risks, foreign currency risks.

22
Chapter 8

• Long-term Obligations

23
Information on Long-term Debt

• Financial information should provide information
  on resources obligation.
• Key issues are credit risk fiscal stress.
• Governments rarely go bankrupt, but essential
  services must go onfiscal stress may make
  providing adequate services problematic.
• General long-term debt includes bonds, notes
  special assessments.
• General obligation (GO) debt is backed by the
  full faith credit of the government ( its
  taxing powers).

24
Accounting for Long-term Debt

• Long-term debt is not included in governmental
  fund statements.
• However, governments must maintain a schedule of
  long-term debt.
• Long-term debt is included in government-wide
  statements, similar to commercial accounting.

25
Government-wide Journal Entries

• GO bonds issued at par
• Cash 500,000 Bonds Payable 500,000
  
• Interest is paid on Bonds
  Interest Expense 15,000 Cash
  15,000
• Interest principal is paid on debt
• Interest Expense 15,000 Bonds Payable
  50,000 Cash 65,000
• Premiums discounts would be amortized over the
  live of the debt (i.e., present value is used).

26
Other Types of Debt

• Demand bonds permit the investor to demand
  redemption early are classified as long-term
  debt (if an appropriate take-out agreements
  exists)
• Bond Anticipation Notes (BANs) short-term notes
  issued will be shortly replaced with long-term
  debt. Usually classified as long-term debt
  (appropriate legal steps for refinancing must
  take place).
• Tax anticipation notes (TANs) revenue
  anticipation notes (RANs) are classified as
  short-term.
• Revenue bonds are backed by specific future
  revenues usually issued by Enterprise Funds.

27
Capital Leases

• Governments can issued both capital operating
  leases (same definitions as commercial
  accounting).
• When issued for governmental purposes Expenditure
  s-capital asset Other Financial Sources-CL
• The interest principal payment in
  DSF Expenditures-Interest Expenditures-Princ
  ipal Cash

28
Capital LeaseGovernment-wide Statements

• Recognize capital lease Capital Asset (CL
  Obligation) Capital Lease Obligation
• Lease payment Capital Lease
  Obligation Interest Expense Cash
• Annual depreciation Depreciation
  Expense Accumulated Depreciation

29
Industrial Development

• Local governments (including Bryan College
  Station) make substantial efforts to encourage
  new business to local in the local area.
  Incentives can include tax abatements,
  government-funded land and/or buildings, etc.
• Governments can issue debt for the benefit of
  non-governments, called conduit debt. This would
  have the lower interest rate of government debt,
  but be serviced by the non-governmental entity.
  Long-term bonds for this purpose are called
  industrial development bonds.

30
Overlapping Debt Debt Margin

• Specific local governments have overlapping
  geographic jurisdictions with other governments
  a city is located within a county, there may be a
  school district any number of special
  districts.
• Particularly important is overlapping debt the
  obligations of property owners for a share of the
  debt of all these governments.
• Most government prepare a schedule of direct (the
  debt of that government) a share of the debt
  of overlapping governments (see pp. 290-1).
• Governments may be limited for the amount of
  long-term debt they can incur, called debt
  margin. This is usually calculated as a of net
  assessed value. If the debt margin is 5 of NAV
  NAV is 315 million, then debt margin is 5 x 315
  million 15.75 million.

31
Bond Ratings

• Ratings of Moodys Standard Poors are the
  most common. Moodys ratings
• AAA is the highest rating BAA-AAA are
  investment grade ratings BA-C are below
  investment grade (junk bonds). It is difficult
  for governments to issue junk bonds
• Interest rates depend on bond ratings ( other
  factors), with interest rates the lowest for the
  highest rated bonds.
• Bond issuers can buy bond insurance from
  Municipal Bond Insurance Association (MBIA)
  other insurers. The premium can be large (up to
  2 of principal interest) for governments with
  high credit risk, but the result is a AAA bond
  rating by Moodys likely lower interest rates.

32
Chapter 9

• Business-type Activities

33
Proprietary Funds

• Most business-type activities of state local
  governments are recorded in Proprietary Funds.
• Enterprise Funds provide goods services for to
  public charge for these services. Examples
  include electric, water, sewage, trash
  utilities certain airport services, land fills,
  etc.
• Internal Service Funds provide goods services
  to other governmental departments charge for
  these services. Typical services include
  computer services, motor pool maintenance,
  copying, etc.

34
Accounting Model

• Proprietary Funds use full accrual accounting
  revenue is recognized when earned expenses are
  used matched to revenue capital assets are
  capitalized depreciated long-term debt is
  recorded. Categories operating revenues (esp.
  charges for services), operating expenses,
  non-operating revenues expenses (e.g.,
  interest).
• Why those activities involve exchange
  transactions, primarily direct charges for goods
  servicesthe basic focus of full accrual.

35
Financial Reporting

• Fund Accounting statement of net assets
  statement of revenues, expenses changes in fund
  net assets statement of cash flows.
• Government-wide statements Proprietary Fund
  amounts are recorded in a separate columns for
  the statement of net assets statement of
  activities.

36
Cash Flow Statement

• Based on GASB Statement 9 somewhat different
  than for commercial firms.
• Cash Flows from Operating Activities
• Cash Flows from Noncapital Financial Activities
• Cash Flows from Capital Related Financing
  Activities
• Cash Flows from Investing Activities

37
Internal Service FundsTypical Entries

• Data processing ISF
• 1. ISF is established from a cash transfer
  (equity/nonreciprocal) from the General Fund,
  100,000. Cash 100,000 Equity
  Transfer In 100,000
• 2. Computer is purchased for cash,
  95,000. Equipment 95,000 Cash
  95,000

38
Internal Service FundsTypical Entries (2)

• Salaries are 35,000 less withholding of 3,800
  Social Security of 2,7000 (due to Federal
  Government). Operating Expenses-Salaries
  35,000 Due to Federal Govern.
  6,500 Salaries Payable 28,500
• General Fund is billed 41,000 Enterprise Fund,
  19,000. Due From General Fund
  41,000 Due From Enterprise Fund
  19,000 Operating Revenues- Charges for
  Services 60,000

39
Internal Service FundsTypical Entries (3)

• Depreciation is recorded for 9,500. Operating
  Expenses- Depreciation 9,500 Accumulate
  d Depreciation 9,500
• Closing Entryequity transfer usually closed to
  invested capital. Equity Transfers
  In 100,000 Ops. Rev.-Char. For Serv.
  60,000 Ops. Exp.-Salaries 35,000 Ops.
  Exp.-Depr. 9,500 Invested in Capital
  Assets 100,000 Net Assets-Unrestricted 21,500

40
Self-Insurance

• A government can self-insure through an Internal
  Service Fund.
• Generally, premiums would be paid from the
  General other Funds, based on actual losses or
  an actuarial method or historical cost method.
  Premiums would be recorded as a credit to
  operating revenues (expenditure in the General
  Fund).
• Claims (losses) would be recorded an asset has
  been impaired or a liability incurred the
  amount can be reasonably estimated. The amount
  would be charged as a debit to Operating
  Expenses-Claims.

41
When to Use an Enterprise Fund

• Governments can use an Enterprise Fund when it
  charges fees to external users for goods
  services.
• An Enterprise Fund is required when it is
  financed solely by revenue debt (plus other
  criteria).
• Example a citys pool complex is funded by both
  charges for services specific taxes. It could
  possibly be accounted for in an Enterprise Fund
  or a Special Revenue Fund. The city can use an
  Enterprise Fund, but must use it if the
  construction was funded exclusively by revenue
  bonds.

42
Typical Entriesa Utility Fund

• Charges for service to non-municipal customers of
  950,000 the General Fund of 10,000 Accounts
  Receivable 950,000 Due From General Fund
  10,000 Operating Revenues 960,000 (Charges
  for Services)
• Provision for Uncollectible accounts was
  increased by 2,000. Operating Expenses-Bad
  Debts 2,000 Allow. For Uncollect. AR 2,000
• Salaries payable of 85,000 are
  recorded. Operating Expenses-Salaries
  85,000 Salaries Payable 85,000

43
Typical Entriesa Utility Fund (2)

• Customer deposits of 8,400 were collected.
  Note there are other methods. Cash-Restr
  icted 8,400 Customer Deposits 8,400
• Interest on revenue bonds of 18,000 was
  paid. Non-operating Expense-Interest
  18,000 Cash 18,000
• Liabilities were recognized for purchase of
  supplies, 14,000 and construction in progress
  for plant assets, 56,000. Supplies
  Inventory 14,000 Construction in
  Progress 56,000 Accounts Payable 14,000 Co
  ntracts Payable 56,000

44
Capital Contributions

• The primary source of capital is an equity
  (non-reciprocal) transfer from the General Fund
  (called Invested in Capital Assets or
  Contributed Capital).
• Other sources of capital may be from contribution
  from other governments contributions from
  developers others. For example, developers may
  put in streets, sidewalks, etc. then
  contribute these assets to the government.
• Note that all transfers or contributions
  would be first recorded in the operating
  statement (statement of revenues, expenses
  changes in net assets).
• Other capital contributions include tap fees
  (charges to customers to hook up to the utility
  system (e.g., water or electricity).
• Net accumulated earnings (Retained Earnings)
  are generally recorded as Unrestricted Net
  Assets.

45
Restricted Assets

• Unlike commercial firms, utilities ( other
  proprietary funds) may have a considerable number
  of restricted assets.
• Cash for customer deposits is usually restricted.
• Revenue bonds may include a number of asset (
  other) restrictions, including use of bond
  proceeds cash set-asides for the repayment of
  principal and/or interest.

46
Landfill Accounting

• Government-owned landfills are usually accounted
  for in an Enterprise Fund (assuming that the
  primary funding if from user charges).
• Operating costs must include the future costs for
  closing the landfill required monitoring. The
  journal entry for this is Landfill
  Expense Liability for Landfill
  Closure (see pp. 322-325).

47
Combined vs. Consolidated Financial Statements

• Fund accounting statement are combined that is,
  the accounting is by fund which included double
  accounting for various transfers, charges for
  services, etc.
• Government-wide statements are consolidated that
  is, the double counting is eliminated.
• Note also that Internal Service Fund activity is
  normally included in the government-wide
  statements under Governmental Activities.