Chapter 6
Accounting for Capital Projects
and Debt Service
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Learning Objectives





Capital Projects Fund
Debt Service Fund
Special Assessments
What is Arbitrage?
Debt Refundings
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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.
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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.
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Capital Projects Funds (cont’d)
 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-toyear focus
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Capital Projects Funds (Cont’d)
Project authorization/preconstruction phase
 Multiyear capital improvement plan

Usually requires long-term financing
-Voter approval required for general obligation (taxsupported) bonds or special taxes for capital
projects (memo entry only for bond/tax
authorization)
-Apply for and obtain grants
-Obtain other forms of financing
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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.
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CPF - Example
Assume that bonds with a face value of $5,000,000
were issued at 101 to finance the project.
Capital Projects Fund:
Cash
Other Financing Sources-Proceeds
of Bonds
Due to Debt Service Fund
Dr.
Cr.
$5,050,000
5,000,000
50,000
Governmental Activities:
Cash
Bonds Payable
Premium on Bonds Payable
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$5,050,000
5,000,000
50,000
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CPF – 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:
Due from other Governmental Units
Revenues
Dr.
Cr.
$100,000
100,000
Governmental Activities:
Due from Other Governmental Units
ProgramRevenues-CapitalGrantsand
Contributions-General Government
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$100,000
100,000
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CPF - Example
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
Due to General Fund
$50,000
50,000
Governmental Activities:
No entry needed.
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CPF - Example
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:
Encumbrances
Reserve for Encumbrances
Dr.
Cr.
$50,000
50,000
Governmental Activities:
No entry needed.
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CPF – 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
Reserve for Encumbrances
Cash
$48,000
50,000
48,000
Encumbrances
50,000
Governmental Activities:
Construction Work in Progress
Cash
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$48,000
48,000
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CPF - Example(cont’d)
Project implementation/construction phase. The
amount due from the federal government for the
previously recorded capital grant was received in
full
Capital Projects Fund:
Dr.
Cr.
Cash
Due from Other Governmental Units
$100,000
100,000
Governmental Activities:
Same entry.
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CPF – Example (cont’d)
The $50,000 due to the General Fund was repaid.
Capital Projects Fund:
Due to General Fund
Cash
Dr.
Cr.
$50,000
50,000
Governmental Activities:
No entry needed.
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Debt Service Funds
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.
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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.
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Types of Tax-Supported Bonds
 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
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Accounting Principles and Procedures
 Modified accrual basis
 Budgetary accounting used
 For serial bonds, the amount budgeted for revenues or interfund 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.
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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.
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Serial Bonds DSF - Example
 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:
Cash
Serial Bonds Payable – 6%
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Dr.
Cr.
$100,000
100,000
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Serial Bond DSF - Example (cont’d)
 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:
Estimated Other Financing Sources
Appropriations
Due from General Fund
Interfund Transfers In
Dr.
$11,000
Cr.
11,000
11,000
11,000
Governmental Activities:
No entry needed.
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Serial Bond DSF - Example (cont’d)
 On May 28, 2007, the transfer from the General
Fund was received.

Debt Service Fund:
Cash
Due from General Fund
Dr.
Cr.
$3,000
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.
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Serial Bond DSF -Example (cont’d)
 The June 1, 2007, interest payment was made
on schedule
Debt Service Fund:
Dr.
Expenditures-Bond Interest
Cash
$3,000
Cr.
3,000
Governmental Activities:
Interest Expense on Long-Term Debt
Cash
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$3,000
3,000
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Serial Bond DSF- Example (cont’d)
 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
Due From General Fund
Expenditures—Bond Principal
Expenditures—Bond Interest
Cash
$8,000
8,000
$5,000
3,000
8,000
Governmental Activities:
Interest Expense on Long-Term Debt
Current Portion of Bonds Payable
Cash
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$3,000
5,000
8,000
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Serial Bond DSF-Example (cont’d)
– Closing entry on December 31, 2007:
Debt Service Fund:
Dr.
Cr.
Appropriations
$11,000
Interfund Transfers In
11,000
Estimated Other Financing Sources
11,000
Expenditures—Bond Principal
5,000
Expenditures—Bond Interest
6,000
Governmental Activities:
Net Assets – Unrestricted
$6,000
Interest Expense on Long-term Debt
6,000
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Special Assessments
 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
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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.
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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.
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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.
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Special Assessments - Example

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:
Assessments Receivable—Current
Assessments Receivable—Deferred
Revenues
Deferred Revenues

Dr.
$100,000
900,000
Cr.
100,000
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:
Cash
Assessments Receivable—Current
Revenues
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Dr.
$180,000
Cr.
100,000
80,000
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Special Assessments Example (cont’d)
 Bond Principal of $100,000 and interest of 8% were paid on
schedule:
Debt Service Fund:
Dr.
Cr.
Expenditures—Bond Principal
100,000
Expenditures—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
Revenues
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100,000
100,000
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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.
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Debt Refunding
 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.
Cash
Cr.
$100,000
Other Financing SourcesProceeds 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.
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Debt Refunding Transactions (cont’d)
 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)
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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
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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.
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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.
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