Chapter 6
Accounting for Capital Projects
and Debt Service
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Learning Objectives
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Capital Projects Fund
Debt Service Fund
Special Assessments
What is Arbitrage?
Debt Refundings
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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.
--i.e. Fund has a “Project-life focus,”
not year-to-year focus.
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Overview
 Governments must maintain capital projects funds for resources
that are legally restricted , committed, or assigned to
expenditure for capital outlays .
 This includes the acquisition or construction of capital facilities
 Fund DOES NOT account for Capital Assets themselves. These
are maintained in a Schedule of Capital Assets.
 Basis of Accounting
 Fund Statements
--Modified accrual basis
 Government-wide statements
--Full accrual basis.
 Two types of capital projects
 General (public benefit)
--Examples: public buildings, roads, highways and bridges, park
improvements, sewer systems, plant and equipment; etc.
 Special assessment (private benefit)
--i.e. Benefits citizens in a specified benefit district.
--Examples: street improvements, curbs, sidewalks, street lighting, sewage,
etc.
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Construction Phases
 Phase 1: Preconstruction Phase
--Project & Financing authorization
 Phase 2: Construction Phase
 Phase 3: Debt Servicing Phase
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Phase 1: Preconstruction Phase
Project & Financing authorization
Financing
Acquire extensive, long-term financing (3 types)
 Type I - Tax Supported Debt
--General obligation (tax-supported) bonds or
special taxes restricted to payment of debt
 Type II - Grants
 Type III - Other forms of financing
--Special Assessments
 (Special Assessments actually claim only 2 phases
because financing & construction are a single phase)
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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:
Issue costs.
Premiums and discounts.
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Type I - Example
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
Other Financing Sources-Bond premium
5,000,000
50,000
Gov’t.-wide (Gov’tal. Activities)*:
Cash
Bonds Payable
Premium on Bonds Payable
$5,050,000
5,000,000
50,000
*Note: This entry is not made on the books, this is the conversion at the eoy
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Type II – Grants: 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
Govt.-wide (Gov’tal. Activities)*:
Dr.
$100,000
Due from Other Governmental Units
$100,000
Program Revenues-Capital Grants and
Contributions-General Government
Cr.
100,000
100,000
*Note: This entry is not made on the books, this is the conversion at
the end of year
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Type II Example (cont’d)
The amount due from the federal government for the
previously recorded capital grant was received in full
Capital Projects Fund:
Dr.
Cash
Due from Other Governmental Units
Cr.
$100,000
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
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Type III – Other Forms of Financing
Overview
Most Common: Special Assessments
--Levied when taxpayers in areas beyond
their jurisdiction want to benefit from
certain facilities and services.
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Additional Topics – CPFs
Interim Financing
May be necessary to obtain interim financing
until proceeds from intended source are
received.
– Used often to complete architectural and
engineering design during preconstruction
phase.
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Interim Financing - Example
Assume for the office building project, $50,000
was borrowed from the General Fund, to be
repaid later from bond proceeds.
Capital Projects Fund:
Cash
Due to General Fund
Dr.
$50,000
Cr.
50,000
Gov’t.-wide (Gov’tal. Activities):
No entry needed.
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Interim Financing Example (cont’d)
The $50,000 due to the General Fund was repaid.
Capital Projects Fund:
Dr.
Due to General Fund
Cash
Cr.
$50,000
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
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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.
GASB requires budgeting over integrated
funds when control cannot be established
by other means (e.g. fixed-price contracts)
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Budgeting - Example (cont’d)
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.
Encumbrances
Reserve for Encumbrances
Cr.
$50,000
50,000
Govt.-wide (Govtal. Activities):
No entry needed.
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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
Reserve for Encumbrances
Cash
$48,000
50,000
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 eoy
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Debt Service Funds(DSF) - Overview
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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
 Taxes levied by DSF
 Taxes levied by GF and transferred to DSF
 Special taxes restricted to the payment of debt
3) Other means of financing
 Special assessments
*2) Grants would not have debt to service
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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. 234-237.
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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
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DSF - Example
Assume bonds are issued on January 1, 2010 and pay
interest semiannually on January 1 and July 1 in the amount
of $100,000. The fiscal year ends on Dec. 31, 2010.
Q: How much expenditures would be
recognized in fiscal 2010?
A: Only the July 1, 2010 interest payment, or
$100,000, would be recognized as an expenditure of
2010.
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Type I - Tax Supported Debt
Overview
Two Types
1) Serial bonds: Two types:
 Regular serial bonds
 Deferred Serial bonds
2) Term bonds
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1) Serial Bonds
Overview
 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.
 Advantage: Self-amortizing;
no sinking fund needed
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Serial Bonds - Example
A certain city issued $100,000 of 6% serial general
obligation (G.O.) bonds on Dec. 1, 2010. In addition,
interest of $3,000 is due on June 1, 2011, December
1, 2011, 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,
2011.
Govt.-wide (Govtal. Activities): Dr.
Cr.
Cash
$100,000
Serial Bonds Payable – 6%
100,000
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Serial Bonds - Example (cont’d)
The budget approved for FY 2011 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
11,000
Due from General Fund
11,000
Interfund Transfers In
11,000
Govt. wide (Govt. Activities):
No entry needed.
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Serial Bonds - Example (cont’d)
On May 28, 2011, the transfer from the General Fund
was received.

Debt Service Fund:
Dr.
Cash
$3,000
OFS-nonreciprocal transfer from GF
Cr.
3,000
(Note: Assuming Interfund (nonreciprocal)Transfers In was accrued at
the time the budget was recorded, thus Interfund Transfers In was
credited here rather than Due from General Fund)
Govt.-wide (Govtal. Activities):
No entry needed.
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Serial Bonds DSF -Example (cont’d)
The June 1, 2011, interest payment was made on
schedule
Debt Service Fund:
Expenditures-Bond Interest
Cash
Dr.
Cr.
$3,000
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
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Serial Bonds- Example (cont’d)
The remaining $8,000 transfer was received from the General
Fund on November 29, 2011. On December 1, the City paid
the interest and principal maturing that date.
Debt Service Fund: (11/29/11)
Dr.
Cr.
Cash
OFS-nonreciprocal transfer from the GF
12/1/11
Expenditures—Bond Principal
Expenditures—Bond Interest
Cash
$8,000
8,000
$5,000
3,000
8,000
Gov’t.-wide (Gov’tal. Activities)*:
Interest Expense on Long-Term Debt
$3,000
Current 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
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Serial Bonds -Example (cont’d)
Closing entries on December 31, 2011:
Debt Service Fund:
Dr.
Cr.
Interfund Transfers In
11,000
Estimated Other Financing Sources
11,000
Appropriations
$11,000
Expenditures—Bond Principal
Expenditures—Bond Interest
5,000
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
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Term Bonds - Overview
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 market value
(fmv)
 Changes in fmv: reported as a component of investment
earnings.
 More complex accounting than for serial bonds
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Type III – Other Forms of Financing
Special 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.
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Special Assessments - Overview (cont’d)
Government 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:
--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.
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.
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Special Assessments - Overview (cont’d)
 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.
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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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$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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Additional Topics
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:
o Arbitrage restrictions.
State and local governments must observe arbitrage regulations.
o 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
• Means 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 rate
• Example in text (p. 245-248) shows there is no real economic
gain or loss from refunding debt
• 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)
• 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”
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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.
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. 247-248
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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 debt
2. Possibility of debtor having to make future payments
on the debt must be remote
3. 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.
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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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