Chapter 6 Accounting for Capital Projects and Debt Service Chapter 6 Granof & Khumawala- 6e 1
Feb 24, 2016
Chapter 6 Accounting for Capital Projects and Debt Service
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
1
Learning Objectives• Capital Projects Fund• Debt Service Fund• Special Assessments• What is Arbitrage?• Debt Refundings
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
2
Capital Projects Funds(CPF)-Definition• A fund that accounts for and report financial resources
that are legally restricted and contractually required for the acquisition of capital assets.
• The primary purpose of this fund is to ensure and demonstrate the expenditure of the dedicated financial resource is both legally and contractually compliant.
• The total cost of a capital project is accumulated in a single expenditures account, which accumulates until
• the project is completed, at which time the fund ceases to exist.o i.e. Fund has a “Project-life focus,”
not year-to-year focus.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
3
Overview• Governments must maintain capital projects funds for
resources that are legally restricted , committed, or assigned to expenditure for capital outlays .o This includes the acquisition or construction of capital facilitieso Fund DOES NOT account for Capital Assets themselves.
These are maintained in a Schedule of Capital Assets.• Basis of Accountingo Fund Statements --Modified accrual basiso Government-wide statements --Full accrual basis.
• Two types of capital projectso General (public benefit)
--Examples: public buildings, roads, highways and bridges, park improvements, sewer systems, plant and equipment; etc.
o Special assessment (private benefit)--i.e. Benefits citizens in a specified benefit district.--Examples: street improvements, curbs, sidewalks, street
lighting, sewage, etc.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
4
Assume that Simple City proceeds with the creation of a capital equipment replacement fund (which would be considered a capital projects fund). To create the fund, the general fund transfers (this means to give – without the expectation of repayment) $1,000,000 to the new capital equipment replacement fund.General Fund
Other financing uses $1,000,000Cash 1,000,000
Capital Equipment Replacement Fund (CPF)Cash $1,000,000Other financing sources 1,000,000
Government-Wide Governmental Activities None
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
5
CPF: Capital Assets- Acquisition
Three Phases: Phase 1: Preconstruction Phase
--Project & Financing authorization Phase 2: Construction Phase Phase 3: Debt Servicing Phase
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
6
CPF: Capital Assets-Construction
Phase 1: Preconstruction Phase Project & Financing authorization
FinancingAcquire extensive, long-term financing (3 types)
• Type I - Tax Supported Debto General obligation (tax-supported) bonds or special taxes
restricted to payment of debt• Type II - Grants• Type III - Other forms of financing
o Special Assessments (Special Assessments actually claim only 2 phases because financing & construction are a single phase)
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
7
Type I Tax Supported Debt
Overview• Voter approval required• Memo entry for bond/tax authorization• Proceeds accounted for as “other financing sources.”• Difference between face value of bonds and cash
received is attributed to:o Issue costs.oPremiums and discounts.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
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-Bond proceeds
5,000,000 Other Financing Sources-Bond premium
50,000 Gov’t.-wide (Gov’tal. Activities)*:
Cash $5,050,000Bonds Payable
5,000,000 Premium on Bonds Payable
50,000
*Note: This entry is not made on the books, this is the conversion at the eoy
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
9
Type I - Example
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 100,000Govt.-wide (Gov’tal. Activities)*:
Due from Other Governmental Units $100,000Program Revenues-Capital Grants andContributions-General Government 100,000
*Note: This entry is not made on the books, this is the conversion at the end of year
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
10
Type II Grants-Example
The amount due from the federal government for thepreviously recorded capital grant was received in full
Capital Projects Fund:Dr. Cr.Cash $100,000
Due from Other Governmental Units 100,000
Gov’t.-wide (Govtal. Activities)*:Same entry.
*Note:This entry is not made on the books, this is the conversion at
the eoy
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
11
Type II Example (cont’d)
OverviewMost Common: Special Assessments--Levied when taxpayers in areas beyond their
jurisdiction want to benefit from certain facilities and services.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
12
Type III – Other Forms of Financing
Additional Topics – CPFs
Interim FinancingMay be necessary to obtain interim financinguntil proceeds from intended source are received.
• Used often to complete architectural and engineering design during preconstruction phase.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
13
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
$50,000Due to General Fund
50,000
Gov’t.-wide (Gov’tal. Activities):No entry needed.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
14
Interim Financing - Example
The $50,000 due to the General Fund was repaid.
Capital Projects Fund: Dr. Cr. Due to General Fund $50,000
Cash 50,000 Gov’t.-Wide (Gov’tal. Activities)*:
No entry needed. (if repaid within period)
*Note: This entry is not made on the books, this is the conversion at the eoy
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
15
Interim Financing Example (cont’d)
Budgeting
• Budgets help ensure control• Since CPF have project (not period) focus, it may be
unnecessary to make annual budgets• But, since numerous projects are “integrated” into a
single fund, budgetary accounts help control individual project expenditures.o GASB requires budgeting over integrated funds when control
cannot be established by other means (e.g. fixed-price contracts)
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
16
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
Government-wide (Gov’tal. Activities):No entry needed.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
17
Budgeting Example (cont’d)
The architectural firm for which an encumbrance of $50,000 had been recorded (see preceding slide), tendered its final billing 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
Gov’t.-wide (Gov’tal. Activities)*:Construction Work in Progress $48,000
Cash 48,000*Note: This entry is not made on the books, this is the conversion at
the end of the year
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
18
Budgeting Example (cont’d)
• Accounts for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest on all general long-term debt.
• This does not include debt issued for and serviced by Enterprise or Internal Service Funds and some Trust Funds
• 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.
• Resources may come from two types:1) Tax Supported Debt
o Taxes levied by DSFo Taxes levied by GF and transferred to DSFo Special taxes restricted to the payment of debt
3) Other means of financingo Special assessments
*2) Grants would not have debt to service
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
19
Debt Service Funds(DSF) - Overview
DSFs - Overview (cont’d)GASB requires DSFs be established when:
• Legally required, or• Financial resources are being accumulated for
principal and interest payments maturing in future years.
GASB recommends:• A single DSF for all debt serviced by property taxes• Governments hold number of funds to a minimum
Refer to the comprehensive example on pgs. 238-241.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
20
DSFs - Overview (cont’d)
Budgets least common for DSFs• If DSF receives fund from other funds, then the
other fund maintains controls• Exception: If resources are derived from special
taxes or assessments, then an appropriations budget enhances control--Decision of budgetary accounts is usually decided legislatively
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
21
DSF - ExampleAssume bonds are issued on January 1, 2013 and pay interest semiannually on January 1 and July 1 in the
amount of $100,000. The fiscal year ends on Dec. 31, 2013.
Q: How much expenditures would be recognized in fiscal 2013?
A: Only the July 1, 2013 interest payment, or $100,000, would be recognized as an expenditure of 2013.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
22
Type I - Tax Supported DebtOverview: Two Types1) Serial bonds:
• Regular serial bonds• Deferred Serial bonds
2) Term bonds
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
23
• Principal matures in annual installments. • 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.o Advantage: Self-amortizing; no sinking fund needed
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
24
1) Serial Bonds - Overview
A certain city issued $100,000 of 6% serial general obligation (G.O.) bonds on Dec. 1, 2013. In addition, interest of $3,000 is due on June 1, 2014, December 1, 2014, 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, 2014.
Gov’t.-wide (Gov’tal. Activities): Dr. Cr.
Cash $100,000 Serial Bonds Payable – 6% 100,000
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
25
Serial Bonds DSF - Example
The budget approved for FY 2014 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 11,000Due from General Fund 11,000
Interfund Transfers In 11,000
Government-wide (Gov’tal. Activities): No entry needed.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
26
Serial Bonds DSF - Example (cont’d)
On May 28, 2014, the transfer from the General Fund was received.
Debt Service Fund: Dr. Cr.Cash $3,000
OFS-nonreciprocal transfer from GF 3,000
(Note: If Interfund (nonreciprocal)Transfers In was accrued at the time the budget was recorded, then Interfund Transfers In would have been credited here rather than Due from General Fund)
Govt.-wide (Gov’tal. Activities): No entry needed.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
27
Serial Bonds DSF - Example (cont’d)
The June 1, 2014, interest payment was made on schedule.
Debt Service Fund: Dr. Cr.Expenditures-Bond Interest $3,000
Cash 3,000
Gov’t.-wide (Gov’tal. Activities)*: Interest Expense on Long-Term Debt $3,000
Cash 3,000
*Note: This entry is not made on the books, this is the conversion at the eoy
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
28
Serial Bonds - Example (cont’d)
The remaining $8,000 transfer was received from the General Fund on November 29, 2014. On December 1, the City paid the interest and principal maturing that date.
Debt Service Fund: (11/29/14) Dr. Cr.Cash $8,000
OFS-nonreciprocal transfer from the GF8,000
12/01/14 Expenditures—Bond Principal $5,000Expenditures—Bond Interest 3,000
Cash 8,000 Gov’t.-wide (Gov’tal. Activities)*: Interest Expense on Long-Term Debt $3,000Current Portion of Bonds Payable 5,000
Cash 8,000*Note: This entry is not made on the books, this is the conversion at
the eoy
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
29
Serial Bonds - Example (cont’d)
Closing entries on December 31, 2014:
Debt Service Fund: Dr. Cr.Interfund Transfers In 11,000
Estimated Other Financing Sources 11,000
Appropriations $11,000Expenditures—Bond Principal 5,000Expenditures—Bond Interest 6,000
Gov’t.-wide (Gov’tal. Activities)*: Net Assets – Unrestricted $6,000
Interest Expense on Long-term Debt 6,000
*Note: This entry is not made on the books, it is the conversion at the eoy
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
30
Serial Bonds - Example (cont’d)
Principal matures in one lump-sum amount at end of the bond term
• Not used as frequently for municipal financing as serial bonds.
Disadvantages: • Usually requires a sinking fund and therefore
investment management• Sinking fund investments: reported at fair value (fv)• Changes in fv: reported as a component of
investment earnings.• More complex accounting than for serial bonds
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
31
Term Bonds-Overview
Type III – Other Forms of FinancingSpecial Assessments - Overview
--benefits only a select group of individuals
Fund Statements • DSF accounted for using modified accrual basis• In the DSF, special assessment revenues and receivables
are accounted for on a full accrual basis
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 the maturity term of the bond. • Property taxes would be recognized as revenues.• Principal of special assessments would be recognized as
both assets and revenues.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
32
Special Assessments-Overview(cont’d)Governments may or may not be obligated to account for special assessment debt (both interest and principle) OBLIGATED:
• Government accounts for debt service on special assessment debt in a DSF when the government is obligated in some manner for the debt.
• GASB states government is obligated if:o It is responsible for the debt in the event of property owner
default, oro t is legally liable for assuming the debt or gives indication
that it may honor the debt in the event of default.NOT OBLIGATED
• Both the special assessment debt and the debt service are accounted for in an agency fund.
• Disclose the amount of debt in the notes to the financial statements.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
33
Special Assessments - Overview (cont.)
• Special Assessments Debt is sometimes paid from a proprietary fund--In this case, all transactions are reported in the proprietary fund.
• Improvements financed with assessments should be capitalized.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
34
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 100,000
Revenues 80,000
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
35
Special Assessments - Example
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 $100,000 Revenues 100,000
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
36
Special Assessments-Example (cont’d)
Additional TopicsArbitrage• 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.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
37
Debt RefundingMeans that existing debt is replaced with new issue of debt – hopefully at a lower interest rate
• Bonds traded on the open market can be repurchased at the going market rateo Example in text (p. 249-251) shows there is no real
economic gain or loss from refunding debto However, there may be a “book” gain or loss: difference
between book value and price paid to retire old bonds
• Existing debt may have a “call feature” that lets the government repay face value early (but several years after original issue date)o Bonds without a call feature that are not actively traded are
more challenging – this is the situation that leads to use of “in-substance defeasance”
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
38
Debt Refunding Transactions• Bond refunding• Refinance• General rule
Debt 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.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
39
Assuming old bonds are retired shortly after issue of refunding bonds
Debt Service Fund: Dr. Cr.
Other Financing Uses—Refunded Bonds $100,000Cash 100,000
(Note: Report only the new issue as debt in governmental activities)
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
40
Debt Refunding Transactions (cont’d)
In-Substance DefeasanceIn-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. 251-252
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
41
In-Substance Defeasance (cont’d)• In-substance defeasance should satisfy the following
conditions:1. Debtor must place cash/assets with an escrow agent to be
solely used for servicing/retiring the debt2. Possibility of debtor having to make future payments on the
debt must be remote3. Assets in escrow fund must be investments considered “risk-
free” like US Treasury Bonds
• Amortize loss (or gain) over future years using the shorter of the original term or the term of the new debt.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
42
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.
Cha
pter
6
Gra
nof &
Khu
maw
ala-
6e
43