Debt Service Funds

1
Debt Service Funds

• Chapter 8

2
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

3
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

4
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

5
Types of Long-Term Liabilities

• Bonds
• Notes
• Time Warrants
• Capital Leases (including leases, lease-purchase
  agreements, certificates of participation, and
  installment purchase contracts)

6
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

7
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

8
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

9
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

10
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

11
Other Bond Terms (continued)

• Funded reserves
• Highest years 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

12
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

13
Typical Debt Service Transactions

• Budgetary entry
• Receipt of financing
• Investments
• Debt service expenditures

14
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
15
2 Financing operations Page 308
Cash OFS Transfer from GF 80,000 80,000
16
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
17
4 Record taxes Page 308
Taxes Receivable Current Allowance for Uncollectible Current Taxes Revenues Property Taxes 165,000 3,000 162,000
18
5 Collect taxes Page 308
Cash Taxes Receivable Current 158,000 158,000
19
6 Record investment earnings Page 308
Cash Revenues Investment Income 4,000 4,000
20
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
100,000
100,000
21
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
22
8 Debt Service ExpendituresAlternate 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.
23
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

24
1 Levy special assessments Page 312
Assessments Receivable Deferred Deferred Revenues Assessments 800,000 800,000
25
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
26
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
27
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
28
5 Special assessment collections Page 313
Cash Assessments Receivable Current Revenues Interest 240,000 185,000 55,000
29
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
30
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

31
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

32
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

33
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

34
Reasons for advance refunding

• Lower effective interest rates
• Extend maturity dates
• Revise payment schedules
• Remove or modify restrictions

35
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

36
Refunding Process
37
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

38
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 doesnt
  disallow the refunding
• Nondefeasance old debt and new debt both stay
  on the books when proper actions are not taken in
  defeasance process

39
DefeasanceSource of Funding vs. Reporting
40
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
2,020,000
2,005,000
15,000
41
Retirement of old bonds Page 324
OFU Retirement of Refunded Term Bonds Cash 2,000,000 2,000,000
2,000,000
2,000,000
42
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
1,915,000
1,900,000
15,000
43
Defeasance of old bonds Page 325
OFU Payment to Refunded Bond Escrow Agent Cash 1,900,000 1,900,000
2,000,000
2,000,000
44
Advance RefundingDebt 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
1,010,000
1,000,000
10,000
45
Advance RefundingDefeasance of old bonds Page
326
Expenditures Debt Service Payment to Refunded Bond Escrow Agent OFU Payment to Refunded Bond Escrow Agent Cash Assumes DSF had 600,000 in existing resources 900,000 1,000,000 1,900,000
2,000,000
2,000,000
46
Advance Refunding DisclosuresYear 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)

47
Advance Refunding DisclosuresSubsequent Years

• Legal Defeasance no subsequent disclosures
  required
• In-Substance Defeasance amount of defeased debt
  still outstanding until all bonds are retired