Issuance and Repayment of Long Term Debt

Issuance and Repayment of Long Term Debt

In the Governmental Funds

GAAP direct that the issuance of long term debt be treated as an "other financing source" rather than revenue to isolate the nonroutine inflow of proceeds that would otherwise distort revenue analysis from year to year. The amount reported as an other financing source should be equal to the face value of the debt. If debt is issued at a premium, the premium should be reported as a separate other financing source.

For accounting purposes, a bond issuance is considered to have taken place as of the closing date ? the date on which the bonds were issued. Therefore, a receivable should be recorded if the issuance occurs prior to year end but the cash proceeds have not yet been received.

The amount of cash actually received is typically less than the face value (plus premium, if applicable) of the debt because:

A portion of the proceeds of long term debt may be withheld for underwriter's fees due in connection with the issuance and/or

The stated interest rate on the debt may have been less than the market rate for similar securities at the time of issuance, in which the case the debt was sold at a discount.

Neither type of discount should be netted against the amount recorded as an other financing source. Instead, discounts resulting from underwriter's fees should be reported as an expenditure and discounts resulting from a difference in interest rates should be treated as an other financing use.

Use Fund 3X to account for the financial resources used to acquire or construct major capital facilities financed as a result of issuing bonds. Bond proceeds are receipted here and accounts payable for all bond projects will be paid for from this fund.

Sample Entry #1:

Bonds are issued with a face value of $6,500,000. $6,450,000 is received from the sale in cash. The balance represents $40,000 in underwriter's fees and $10,000 in discounts due to a difference in the market and stated interest rates.

Dr. 3X..00101.001 Cash

$6,450,000

Dr. 3X..15121.833 Expenditures ? Debt Service Fees/Commissions 40,000

Dr. 3X..15121.925 Other Financing Use ? Bond Discount

10,000

Cr. 3X..05111.009 Other Financing Source ? Bond Proceeds

$6,500,000

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Sample Entry #2:

Bonds are issued with a face value of $3,750,000. $4,100,000 is received from the sale in cash. The balance represents $30,000 in underwriter's fees and $380,000 in bond premium.

Dr. 3X..00101.001 Cash

$4,100,000

Dr. 3X..15121.833 Expenditures ? Debt Service Fees/Commissions 30,000

Cr. 3X..05111.009 Other Financing Source ? Bond Proceeds

$3,750,000

Cr. 3X..05121.009 Other Financing Source ? Bond Premium

380,000

GAAP direct that expenditures related to debt service principal and interest payments be recognized in governmental funds in the period in which they become due.

Use Fund 2X to account for the accumulation of resources for, and the payment of, general long term debt, principal and interest. Property tax revenues from a bond levy are receipted here and payments for principal and interest on maturing bonds are recorded in this fund.

Sample Entry #3:

Interest payments of $25,000 are due on March 31 and September 30 of each year. Principal is due on September 30 in the amount of $325,000.

Dr. 2X..15111.831 Redemption of Principal Cr. 2X..00101.001 Cash

$325,000 $325,000

Dr. 2X..15121.832 Interest Expense Cr. 2X..00101.001 Cash

25,000 $25,000

In the Entity-Wide Statements

Governmental funds report only those liabilities that are expected to be liquidated with current available financial resources. Therefore, governmental funds typically report no liability for the unmatured principal of bonds, notes, capital lease obligations and similar debt. All debt, however, must be reported in the entity-wide statements. Consistent with the treatment for long-term debt, governmental funds typically do not report a liability for accrued interest until it is due and payable. Accrued interest must be reported as a liability in the entity-wide statements.

From a full accrual perspective, the payment of debt service principal has no effect on net assets. Consequently, debt service expenditures for principal payments are not expenses and should not be included in the entity-wide statement of activities. The same approach should be taken to other

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financing uses reported in connection with current or advance refunding transactions. In addition, debt issuance has no impact on net assets, but instead affects only accounts reported on the statement of position. Accordingly, other financing sources, uses and expenditures associated with the issuance of debt should not be included in the entity-wide statement of activities. Sample conversion entries follow. These are entries are made separate from the WVEIS accounting system on separate files.

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Conversion Entries (N, P)

Convert debt principal payments to reduction of liability Action Needed: Debt principal payments are recorded as expendtiures in the governmental funds but should be shown as a reduction of the

liability in the entity-wide statements.

Conversion Entries (N P): dr. BONDS PAYABLE

cr. Expenditures-Debt service-principal retirement dr. CAPITAL LEASE PAYABLE

cr. Expenditures-Debt service-principal retirement

Where do the Numbers Come From?

$ 2,520,000 $

$

76,923

$

2,520,000 76,923

Long-term debt table

Bonds payable General obligation debt Compensated absences Accrued sick leave Capital lease payable

Balance, Beginning of Year 10,550,000 175,448 3,388,703 769,231

Restatement -

7,113,568

-

Long-term liabilities

14,883,382

7,113,568

Additions -

573,976 -

573,976

Deductions 2,520,000 76,923

2,596,923

Balance, End of Year

8,030,000 749,424

10,502,271 692,308

Amounts due within one year 2,600,000 10,502,271 76,923

Amounts due past one year

5,430,000 749,424 615,385

19,974,003

13,179,194

6,794,809

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Conversion Entry (S)

Amortize bond issuance costs in the entity-wide statements

Action Needed: When incurred, total bond issuance costs are recorded as expenditures in the governmental funds. If material, they should be capitalized in the entity-wide statements and amortized over the length of the bond. Deferred charges for bond issuance costs are treated much like a prepaid asset.

Conversion Entry:

To record one year's amortization of the bond issuance costs. dr. Expenditures-support services-business

cr. DEFERRED CHARGES-BOND ISSUANCE COSTS

$

13,200

$

13,200

Where do the Numbers Come From?

Total Bond Issuance costs

$

66,000

Length of bond

5

This is the second year of the bond

Amount to amortize each year

$

13,200

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Conversion Entry (V)

Record interest due but not paid as of June 30

Action Needed: Interest that has accumulated on debt but has not been paid as of June 30 must be accrued in the entity-wide statements to comply with full accrual accounting. Interest is recorded only when paid in the governmental funds.

Conversion Entry:

dr. ACCRUED INTEREST PAYABLE cr. NET ASSETS

To adjust the balance in accrued interest payable.

$

11,550

$

11,550

Where do the Numbers Come From?

Interest payment amount Payable March 30 and September 30 each year Portion accrued at June 30 ((113,632/6 months) x 3 months)

Balance in accrued interest payable

Entry needed to adjust balance to actual at June 30 $

90,532

45,266 56,816 (11,550)

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Arbitrage

The interest paid on most debt issued by state and local governments is not subject to federal income tax. As a result, purchasers of this type of debt are willing to accept a lower interest rate than they would on taxable debt. Governments sometimes temporarily reinvest the proceeds in materially higheryielding taxable securities, especially during construction projects. This practice is called "arbitrage" by the federal tax code. It is possible in certain specific situations, called "safe harbors", for governments to keep the extra earnings that result from arbitrage. In all other cases, any excess earnings resulted from arbitrage must be rebated to the federal government. The liability to the federal government for any excess earnings is therefore known as "rebatable arbitrage". Typically, arbitrage rebate payments must be made to the federal government every five years and at final maturity.

Rebatable arbitrage falls within the category of claims and judgments. Governmental funds may not recognize a liability for claims and judgments (and also rebatable arbitrage) until amounts actually become due and payable. Therefore, governmental funds should not report either an expenditure or liability in connection with rebatable arbitrage until payment is actually made or the liability has become due and payable.

It is recommended, however, that monies be set aside in a budgetary reserve in an amount sufficient to provide for the rebatable arbitrage when it becomes due. An arbitrage calculation should be performed annually to determine the estimated rebate amount.

Sample documents follow to illustrate the process.

Sample Entry #4:

Record the arbitrage payment due at March 31 of $1,225,000:

Dr. 3X..15121.833

Debt Service Fees/Commissions

Cr. 3X..00101.001

Cash

$1,225,000 $1,225,000

Use this sample entry if the arbitrage payment is due and payment is remitted within the same accounting period. If monies have been transferred to Fund 11 and the payment is made from that fund, then fund code 11 will be used in place of 3X.

Sample Entry #5: (See sample documents following this page)

Record the arbitrage payment due at June 30, but not paid by that date of $1,332,977:

Dr. 3X..15121.833

Debt Service Fees/Commissions

Cr. 3X..00448.004

Arbitrage Rebate Payable

$1,332,977 $1,332,977

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Then record the subsequent cash payment:

Dr. 3X..00448.004

Arbitrage Rebate Payable

Cr. 3X..00101.001

Cash

$1,332,977 $1,332,977

Use this sample entry if the actual payment is made in an accounting period subsequent to the period in which the payment becomes due and payable. If monies have been transferred to Fund 11 and the payment is made from that fund, then fund code 11 will be used in place of 3X.

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