AC456 Chapter 6: Accounting for General Long-Term Debt and Debt Service

Full Faith and Credit

General long-term liabilities are backed by the "full faith and credit" of the governmental unit incurring the debt. This means that the debt is secured by a governmental unit's ability to levy and collect taxes.

Special Assessments (Obligated)

If the governmental unit is either "primarily" or "potentially" liable for the debt, the accounting will take place as if it were any other capital improvement and financing transaction. The following would be appropriate: -Construction activities will be recorded in the CPF and in the governmental activities journal at the government-wide level. -Servicing any special assessment debt and the assessments receivables would be recorded in a DSF and in the governmental activities journal at the government-wide level. -The completed project would be recorded in the governmental activities journal at the government entity-wide level. -The Special Assessment debt obligation (the bond issue) would be recorded in the governmental activities journal at the government-wide level.

Special Assessments (Not Obligated)

If the governmental unit is not obligated in any way for the special assessment debt, the special assessment activities will be accounted for as follows: -Construction activities will be recorded in a CPF and in the governmental activities journal at the government-wide level. -Debt principal and interest payment activities along with the assessments receivable (but not the special assessment debt) would be recorded in an AGENCY FUND. No entries are required in the governmental activities journal at the government-wide level. -The completed project would be recorded in the governmental activities journal at the government entity-wide level. -The special assessment bond issue would NOT be recorded on the books of the governmental unit. The debt obligation would be reported in footnotes.

In-Substance Defeasance

In-substance defeasance occurs when debt is considered defeased for accounting and financial reporting purposes even though legal defeasance has not occurred. GASB Codification Section D20.103 sets forth in detail the circumstances for in-substance defeasance. Briefly, the debtor must irrevocably place cash or other assets with an escrow agent in as trust to be used solely for satisfying scheduled payments of both interest and principal of the defeased debt, and the possibility that the debtor will be required to make future payments on the debt is remote. The trust is restricted to owning only monetary assets that are essentially risk-free as to the amount, timing, and collection of interest and principal.

Defeasance of Old Debt

The term defeased means terminated or rendered null and void. Debt that has been defeased is thus considered to be extinguished and is removed from the government-wide accounts and is NOT reported in the balance sheet. In advance refunding, it is not possible to actually pay off the old debt with the proceeds of the new substitute debt. Instead, the old debt may remain outstanding for much or all of its originally scheduled life and be serviced by the resources of an IRREVOCABLE TRUST financed by the proceeds of the new refunding debt issue. In such cases, the old debt is considered to be extinguished (and is removed form the government-wide accounts and the balance sheet) if it is either LEGALLY DEFEASABLE or DEFEASED IN SUBSTANCE.

Debt Margin

This is the DIFFERENCE BETWEEN THE AMOUNT OF DEBT LIMIT CALCULATED AS PRESCRIBED BY LAW AND THE NET AMOUNT OF OUTSTANDING INDEBTEDNESS subject to the limitation, adjusted for amounts available in the DSF for debt repayment.

General Long-Term Debt Liabilities

-Debt Instruments -Bond anticipation notes -Demand bonds -Loss contingencies -Compensated absences -Special termination benefits -Leases -Pensions

Important Accounting Principles at the Fund Level (DSF)

-Modified accrual basis -Record the annual budgets -Encumbrance accounting is not required -DO NOT ACCRUE BOND INTEREST PAYABLE BEFORE IT IS LEGALLY DUE -All long-term investments in debt and equity securities held for repayment of general long-term debt principal are reported at FAIR VALUE in the DSF balance sheet. All changes in the fair value of investments during the period, both realized and unrealized, are reported as revenue in the Statement of Revenues, Expenditures, and Changes in Fund Balances -Accrue investment earnings

Special Assessments

A special assessment is a compulsory levy made against certain property to defray part or all of the cost of a specific improvements or service that is presumed to be of general benefit to the public and of particular benefit to the property against which the special assessment is levied.

Debt Refunding Journal Entries

DSF: dr Cash cr Other Financing Sources - Debt Refunding (issue new debt) Govt'l Activity: dr Cash cr Bonds Payable (New Bond) DSF: dr Expenditure - Interest dr Expenditure - Principal cr Cash (paid off old debt plus int) Govt'l Activity: dr Interest Expense dr Bonds Payable (old bond) cr Cash

Overlapping Debt

Debt limitation laws ordinarily establish limits that may not be exceeded by each separate governmental unit affected by the laws. This means the county government may incur indebtedness to the legal limit, a township within that county may do likewise, and a city within the township may become indebted to the legal limit, with no restriction because of debt already owed by larger territorial units in which it is located. As a result, a given parcel of real estate may be the basis of debt beyond the so-called legal limit. When this situation exists, it is described as overlapping debt.

Debt Refunding

Debt refunding occurs when new debt is issued because sufficient resources have not been accumulated for debt repayment, or the interest rate on new debt is appreciably lower, or if the covenants of the old bonds are excessively burdensome. The proceeds of the new debt are used to liquidate the old obligation.

Types of Bonds

Term Bonds: -All of the principle is payable at a single specified maturity date. Serial Bonds: -Bonds that provide for periodic maturities. Specific arrangements of maturities vary widely. 1) Regular: - The total principal of an issue is repayable in a specified number of equal annual installments over the life of the issue. 2) Deferred: - The first installment is delayed for a period of more than one year after the date of the issue, but thereafter installments fall due on a regular basis. 3) Annuity: - The amount of annual principal repayments is scheduled to increase each year by approximately the same amount that interest payments decrease so that the total debt service remains reasonably level over the term of the issue. 4) Irregular: - May have any pattern of repayment that does not fit the other three categories.

GASB Statement 6

The accounting for special assessment projects depends on the liability of the governmental unit for the special assessment debt. That is, whether or not the governmental unit is obligated in any way for the special assessment debt.

Debt Service Funds

The purpose of a debt service fund is to account for the accumulation of resources for, and the payment of general long-term debt principal and interest. Thus, only "general government" long- term debt is serviced through the DSF. It should be noted that not all general long term debt must be serviced through the DSF. The GASB standards provide that "debt service funds are required only if they are legally mandated and/or if financial resources are being accumulated for principal and interest payments maturing in future years." If neither law nor sound financial administration require the use of debt service funds, the function may be performed within the accounting and budgeting framework of the general fund. It should be noted, however, that most government accountants prefer to account for all general long term debt service through one or more debt service funds. This tends to enhance control over and accountability for debt service resources.

Debt Limit

This is the MAXIMUM AMOUNT OF DEBT THAT A GOVERNMENTAL UNIT CAN HAVE OUTSTANDING. It is usually stated as a percent of the assessed valuation of property within the government's jurisdiction. The calculation can be in terms of either gross or net valuation. Net valuation means the gross value less non-taxable property (e.g. churches, governmental property, property with a homestead exception, etc.)

General Long-Term Debt

When debt proceeds are used for general purposes. - General long-term debt IS NOT accounted for as fund liabilities of governmental funds. - General long-term debt IS recorded as liabilities in the governmental activities level and reported in the government-wide Statement of Net Assets.

Legal Defeasance

When the debtor complies with the defeasance provisions of the debt indenture (the legal requirements).

Advance Debt Refunding

occurs when a government issues new general long-term debt to service old long-term debt prior to its maturity. This is in essence substituting the new debt for the old debt. Reasons for Advance Refunding: -Lower effective interest rates -Extended maturity dates -Revised payment schedule -Remove or modify restrictions

Normal Debt Refunding

the new debt is issued at the maturity of the old debt, or during an early call period.