Chapter 6 1

Chapter 6

Accounting for Capital Projects and Debt Service

Chapter 6 2

Learning Objectives

Capital Projects Fund Debt Service Fund Special Assessments What is Arbitrage? Debt Refundings

Chapter 6 3

Capital Project Funds Accounts for resources dedicated to the purchase

and construction of capital facilities. Legally restricted. Accounted for on the modified accrual

basis. Government-wide statements: full

accrual basis. Examples: Buildings, infrastructure

projects such as roads, bridges, airports,sewer systems, and plant and equipment.

Chapter 6 4

Capital Projects Funds

Two types of capital projects General (public benefit)

Examples: public buildings, roads, highways and bridges, park improvements; etc.

Special assessment (private benefit)Examples: street improvements, curbs,

sidewalks, street lighting, sewage, etc.

Deemed to benefit citizens in a specified benefit district.

Chapter 6 5

Characteristics of capital projects

-Involves long-lived assets (e.g, buildings, roads and bridges, etc.)

-Usually involves a construction project

-Usually requires long-range planning and extensive financing

-Have a project-life focus, rather than a year-to-year focus

Capital Projects Funds (cont’d)

Chapter 6 6

Project authorization/preconstruction phase Multiyear capital improvement plan

Usually requires long-term financing -Voter approval required for general obligation (tax-

supported) bonds or special taxes for capital projects (memo entry only for bond/tax authorization)

-Apply for and obtain grants

-Obtain other forms of financing

Capital Projects Funds (Cont’d)

Chapter 6 7

Capital Project Funds (cont’d)

• Commonly financed with bonds or other forms of long-term debt, grants, special tax levies, or assessments.

• Proceeds of bonds or other long-term obligations are accounted for as “other financing sources.”

• Difference between face value of bonds and cash received is attributed to:– Issue costs.– Premiums and discounts.

Chapter 6 8

Assume that bonds with a face value of $5,000,000 were issued at 101 to finance the project.

Capital Projects Fund: Dr. Cr.

Cash $5,050,000

Other Financing Sources-Proceeds of Bonds 5,000,000Due to Debt Service Fund 50,000

Governmental Activities:

Cash $5,050,000

Bonds Payable 5,000,000 Premium on Bonds Payable 50,000

CPF - Example

Chapter 6 9

Assume approval is obtained for a federal grant as partial funding for a city’s office building project.

Upon approval, the following journal entry would be made:

Capital Projects Fund: Dr. Cr.Due from other Governmental Units $100,000

Revenues 100,000

Governmental Activities:Due from Other Governmental Units $100,000

ProgramRevenues-CapitalGrantsandContributions-General Government

100,000

CPF – Example

Chapter 6 10

It may also be necessary to obtain interim financing, particularly to complete architectural and engineering design. Assume for the office building project, $50,000 was borrowed from the General Fund, to be repaid later from bond proceeds.

Capital Projects Fund: Dr. Cr.Cash $50,000

Due to General Fund 50,000

Governmental Activities:No entry needed.

CPF - Example

Chapter 6 11

A contract was let in the amount of $50,000 with an architectural firm to complete the architectural design for the new city office building. The following entry would be required in the capital projects fund.

Capital Projects Fund: Dr. Cr.Encumbrances $50,000

Reserve for Encumbrances 50,000

Governmental Activities:No entry needed.

CPF - Example

Chapter 6 12

The architectural firm for which an encumbrance of $50,000had been recorded (see preceding slide), tendered its finalbilling in the amount of $48,000. The city immediately paid the

amount due. Capital Projects Fund: Dr. Cr.Construction Expenditures $48,000 Reserve for Encumbrances 50,000

Cash 48,000

Encumbrances 50,000

Governmental Activities:Construction Work in Progress $48,000

Cash 48,000

CPF – Example (cont’d)

Chapter 6 13

Project implementation/construction phase. The amount due from the federal government for the previously recorded capital grant was received in fullCapital Projects Fund: Dr. Cr.Cash $100,000

Due from Other Governmental Units 100,000

Governmental Activities:Same entry.

CPF - Example(cont’d)

Chapter 6 14

The $50,000 due to the General Fund was repaid.

Capital Projects Fund: Dr. Cr.

Due to General Fund $50,000

Cash 50,000

Governmental Activities:

No entry needed.

CPF – Example (cont’d)

Chapter 6 15

Characteristics of Debt Service Funds Accounts for resources accumulated to pay interest

and principal on long-term debt.

Accounts for financial resources set aside for principal and/or interest on general long-term liabilities only and payments of said amounts

GASB says that debt service funds be established when:

-Legally required, or

-Financial resources are being accumulated for principal and interest payments maturing in future years.

Debt Service Funds

Chapter 6 16

Debt Service Funds (cont’d)

Resources may come from-Taxes levied by DSF-Taxes levied by GF and transferred to DSF-Special assessments

Hold number of funds to a minimum GASB recommends a single DSF for all tax-supported

debt serviced by property taxes. Debt service funds: accounted for on the modified

accrual basis. Exception: Interest and principal are NOT considered

current liabilities of DSF until the period in which they must be paid but the interest revenue on bonds held as investments is accrued.

Refer to the comprehensive example on pgs. 226-229.

Chapter 6 17

Serial bonds-Principal matures in annual installments.

-Advantage: Self-amortizing; no sinking fund needed

Regular serial bonds

Deferred Serial bonds Term bonds

-Principal matures in one lump-sum amount at the end of the bond term -Not used as frequently for municipal financing as serial bonds. -Disadvantage: Usually requires a sinking fund and therefore investment

management-More complex accounting than for serial bonds

Types of Tax-Supported Bonds

Chapter 6 18

Modified accrual basis

Budgetary accounting used

For serial bonds, the amount budgeted for revenues or inter-fund transfers in, is usually just what is needed that fiscal year for matured principal and interest.

Sinking fund investments: reported at fair market value (fmv)

-Changes in fmv: reported as a component of investment earnings.

Taxes levied by debt service fund Taxes levied by General fund and transferred

to debt service fund.

Accounting Principles and Procedures

Chapter 6 19

DSF - Example Assume bonds are issued on January 1, 2007 and pay

interest semiannually on January 1 and July 1 in the amount of $100,000. The fiscal year ends on December

31, 2007. Q: How much expenditures would be

recognized in fiscal 2007?

A: Only the July 1, 2007 interest payment, or $100,000, would be recognized as an expenditure of 2007.

Chapter 6 20

A certain city issued $100,000 of 6% serial general obligation (G.O.) bonds on Dec. 1, 2006. In addition, interest of $3,000 is due on June 1, 2007, December 1, 2007, and in decreasing amounts every June 1 and Dec. 1 for the next 19 years after that. The first principal maturity of $5,000 is due on December 1, 2007.

Governmental Activities: Dr. Cr.Cash $100,000

Serial Bonds Payable – 6% 100,000

Serial Bonds DSF - Example

Chapter 6 21

The budget approved for FY 2007 requires the General Fund to transfer $11,000 to the DSF for debt service which includes principal repayment of $5,000 and two interest payments totaling $6,000.

Debt Service Fund: Dr. Cr.

Estimated Other Financing Sources $11,000

Appropriations 11,000

Due from General Fund 11,000

Interfund Transfers In 11,000

Governmental Activities: No entry needed.

Serial Bond DSF - Example (cont’d)

Chapter 6 22

On May 28, 2007, the transfer from the General Fund was received.

Debt Service Fund: Dr. Cr.Cash $3,000 Due from General Fund 3,000

(Note: If Interfund Transfers In had not been accrued at the time the budget was recorded, then Interfund Transfers In would be credited here rather than

Due from General Fund)

Governmental Activities:No entry needed.

Serial Bond DSF - Example (cont’d)

Chapter 6 23

The June 1, 2007, interest payment was made on schedule

Debt Service Fund: Dr. Cr.Expenditures-Bond Interest $3,000

Cash 3,000

Governmental Activities:Interest Expense on Long-Term Debt $3,000

Cash 3,000

Serial Bond DSF -Example (cont’d)

Chapter 6 24

The remaining $8,000 transfer was received from the General Fund on November 29, 2007. On December 1, the City paid the interest and principal maturing that date.

Debt Service Fund: Dr. Cr.Cash $8,000

Due From General Fund 8,000 Expenditures—Bond Principal $5,000

Expenditures—Bond Interest 3,000 Cash 8,000

Governmental Activities: Interest Expense on Long-Term Debt $3,000

Current Portion of Bonds Payable 5,000 Cash 8,000

Serial Bond DSF- Example (cont’d)

Chapter 6 25

– Closing entry on December 31, 2007:

Debt Service Fund: Dr. Cr.

Appropriations $11,000Interfund Transfers In 11,000

Estimated Other Financing Sources 11,000Expenditures—Bond Principal 5,000Expenditures—Bond Interest 6,000

Governmental Activities:Net Assets – Unrestricted $6,000

Interest Expense on Long-term Debt 6,000

Serial Bond DSF-Example (cont’d)

Chapter 6 26

Levied when taxpayers in areas beyond their jurisdiction want to benefit from certain facilities and services.

Capital improvement special assessments involve 2 phases:

-Construction phase

-Debt service phase

Special Assessments

Chapter 6 27

Special Assessments (cont’d)

Account for debt service on special assessment debt in a DSF when the government is obligated in some manner for the debt.

The interest and principal payable: accounted for in a debt service fund.

GASB requires a government to account for the debt if:

-It is responsible for the debt in the event of property owner default, or

-It is legally liable for assuming the debt or gives indication that it may honor the debt in the event of default.

Chapter 6 28

Special Assessments (cont’d)

If the government is not obligated in some manner: Both the debt and the debt service are accounted

for in an agency fund. Construction activities are reported in capital

projects fund. Capital assets are reported in the schedule of

capital assets and government-wide statements. Disclose the amount of debt in the notes to the

financial statements.

Chapter 6 29

Special Assessments (cont’d) If special assessment debt paid from a proprietary fund: all

transactions should be reported in a proprietary fund. Special assessment revenues and receivables: accounted

for in a full accrual basis Improvements financed with assessments should be

capitalized. In government-wide statements:

-Interest on long-term debt would be accrued and charged as an expense.

-Discounts and premiums on bonds payable would be amortized over time.

-Property taxes would be recognized as revenues. -Principal of special assessments would be recognized

as both assets and revenues.

Chapter 6 30

Example: $1,000,000 of special assessments were levied on property owners in a special benefit district, payable in 10 equal annual installments of $100,000 each.

Debt Service Fund: Dr. Cr.Assessments Receivable—Current $100,000Assessments Receivable—Deferred 900,000

Revenues 100,000 Deferred Revenues 900,000

Assume all current Assessments Receivable were collected during fiscal year along with 8% of interest on the previous unpaid balance. The entry would be:

Debt Service Fund: Dr. Cr.Cash $180,000

Assessments Receivable—Current 100,000Revenues 80,000

Special Assessments - Example

Chapter 6 31

Bond Principal of $100,000 and interest of 8% were paid on schedule:

Debt Service Fund: Dr. Cr.Expenditures—Bond Principal 100,000Expenditures—Bond Interest 80,000

Cash 180,000

Early next year, the following reclassification entries would be made:

Debt Service Fund: Dr. Cr.Assessments Receivable—Current 100,000

Assessments Receivable—Deferred 100,000

Deferred Revenues 100,000Revenues 100,000

Special Assessments Example (cont’d)

Chapter 6 32

Arbitrage Arbitrage: Investment of idle cash Issuance of debt at low tax-exempt interest rates and

investment of proceeds in taxable securities yielding higher return.

Interest received is exempt from federal taxes. 2 Provisions to prevent arbitrage abuse:

-Arbitrage restrictions. State and local governments must observe arbitrage

regulations. -Rebate on arbitrage.

Arbitrage rules and regulations are complex and contain several exemptions and exceptions.

Investment revenues should be reduced and rebate liabilities established.

Chapter 6 33

Debt Refunding Bond refunding Refinance General ruleDebt Refunding Transactions:Entries in DSF, assuming that because of reduced market rates of interest, $100,000 of previously issued bonds are refunded by a new $100,000 bond issue with lower interest payments

When refunding (new) bonds are issued:

Debt Service Fund: Dr. Cr. Cash $100,000 Other Financing Sources-

Proceeds of refunding (new) Bonds 100,000

If old bonds are not retired by the end of the fiscal year, both issues would be reported as long-term debt in governmental activities.

Chapter 6 34

Assuming old bonds are retired shortly after issue of refunding bonds

Debt Service Fund: Dr. Cr.

Other Financing Uses—Refunded Bonds $100,000

Cash 100,000

(Note: Report only the new issue as debt in governmental activities)

Debt Refunding Transactions (cont’d)

Chapter 6 35

In-Substance Defeasance

In-substance defeasance (advance refunding) Provision for the government to lock the

savings that would result from a decline in the interest rates.

Advance refunding in which the borrower economically satisfies its existing obligations.

Journal entries are similar to those for regular refundings.

Refer to the example on pgs. 239-240

Chapter 6 36

In-Substance Defeasance (cont’d)

In-substance defeasance should satisfy the following conditions:

Debtor must place cash/assets with an escrow agent to be solely used for servicing/retiring the debt

Possibility of debtor having to make future payments on the debt must be remote

Assets in escrow fund must be risk-free. 3 possibilities to recognize loss:

-Over the prior years in which the debt has been outstanding

-At the time of defeasance

-Amortize it over the future years.

Chapter 6 37

Summary Capital Projects and Debt Service Fund are accounted for on a

modified accrual basis. The principles for revenue and expenditure are the same as the

General fund. Accordingly, the long-term assets and liabilities are accounted for “off the balance sheet.”

Special Assessments are accounted for just as any other capital projects.

In Government-wide statements, both CPF and DSF are combined with other governmental funds. Both revenues and expenses are recognized on a full accrual basis.

Arbitrage is issuing of debt at relatively low, tax-exempt interest rates.

Bond refunding is the early retirement of existing (high interest) debt with so that it can be replaced with new (low interest) debt.

Chapter 6 38

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