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Debt Service Funds

Chapter 8

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, and report
refundings of GLTL

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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

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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

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Types of Long-Term Liabilities


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

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Bonds

Usually issued in $1,000 or $5,000


denominations
Maturity runs from 15 to 25 years
Interest paid annually or semi-annually
Types
Serialthe

most widely used, principal comes due in


installments
Termprincipal comes due at a single point in time

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Notes
Typically less formal than bonds
May be

Short-term30

to 90 daysreported as fund

liabilities
Long-term5 to 10 yearsreported in GLTL

Single note used for entire transaction


rather than multiple bonds
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Warrants

Notesmultiple 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

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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

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Other Bond Terms

Interest rates
Fixedmost

commonaids in planning for

expenditures
Variablemore flexibility

Debt service paymentstry to minimize


fluctuations
Fiscal agentsprocess interest and
principal payments

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Other Bond Terms (continued)

Funded reserves
Highest

years principal and interest


Give bondholders additional assurance of prompt
payments
Will affect Restricted Fund Balance

Bond ratingsaid in determining interest rates


and reserves
Bond insurancehelps lower interest rates and
reserves; may assist is issuance of bonds
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Other Bond Terms (continued)

Sources of financing to repay bondsproperty


taxes, sales taxes, or first revenues accruing to
treasury
Investmentsexcess funds invested until
needed; must keep arbitrage in mind
Expenditure recognitionusual classifications
Interest
Principal
Fiscal

agent fees

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Typical Debt Service Transactions


Budgetary entry
Receipt of financing
Investments
Debt service expenditures

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Financial Statements
Balance Sheet
Statement of Revenues, Expenditures,
and Changes in Fund Balance
Budget-to-Actual Statementoptional
would be presented as part of
Supplementary Information

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Fund Balance Presentation


Restricted amounts for funded reserve
Committed may be used for amounts
transferred from other funds
Assigned for the balance
Unassigned used only if negative amount
needed to balance Fund Balance
Assigned Fund Balance would be zero

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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 for
project and make collections for repayment of debt

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Unique Characteristics of SA DSFs

Most of receivables are noncurrentcome due


in annual installments
Levy is only on benefitted properties for special
assessment work
Revenue accounting follows same principles as
other property taxes
Noncurrent receivables offset by deferred inflow
(deferred revenues)
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Use of DSF Not Always Required

DSF used only if government is obligated in


some manner on the debtGASBS 6 provides
criteria
If not obligated
Government

serves as conduit for repayment from


property owners to debt holders
No entry in GLTL
Agency Fund used for collection and subsequent
payments
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Other DSF Issues

Interest on debt 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
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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

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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

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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

Refundingusing new bonds to substitute


for old bonds

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Reasons for Advance Refunding


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

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GASB Defines Refunding


Issuing new debt whose proceeds are used
to repay previously issued (old) debt
Current refundingnew debt proceeds
used to repay old debt immediately
Advance refundingnew debt proceeds
placed with escrow agent and invested
until used to pay old debt principal and
interest in the future
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Refunding Process
CURRENT REFUNDINGS
Debtor

Proceeds of New Debt Issue

Refunding (New)
Debt Issue

Investor
Refunded (Old)

Retired Old Debt Securities

Debt Issue

ADVANCE REFUNDINGS
Proceeds
of New
Debt Issue

Debt Service
Payments on Old
Debt Issue (over
remaining term
or until call date*

Bank or Other Trust


Department or Agency
Proceeds invested in irrevocable trust
to service Old Debt Issue

* Debt securities are eventually retired and returned to the debtor


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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
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Types of Defeasances

Legalbond covenant of old debt includes


defeasance provisions
In-substancebond covenant of old debt does
not include defeasance provisions, but doesnt
disallow the refunding
Nondefeasanceold debt and new debt both
stay on the books when proper actions are not
taken in defeasance process

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Defeasance:
Source of Funding vs. Reporting

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Advance Refunding Disclosures:


Year 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)

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Advance Refunding Disclosures:


Subsequent Years
Legal Defeasanceno subsequent
disclosures required
In-Substance Defeasanceamount of
defeased debt still outstanding until all
bonds are retired

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