Chapter 6
Accounting for Capital Projects
and Debt Service
Granof & Khumawala-6e
Chapter 6
1
Granof & Khumawala-6e
• Capital Projects Fund
• Debt Service Fund
• Special Assessments
• What is Arbitrage?
• Debt Refundings
Chapter 6
Learning Objectives
2
Granof & Khumawala-6e
• 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.
Chapter 6
Capital Projects Funds(CPF)Definition
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Overview
• Basis of Accounting
o Fund Statements --Modified accrual basis
o Government-wide statements --Full accrual basis.
• Two types of capital projects
o 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.
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o This includes the acquisition or construction of capital facilities
o Fund DOES NOT account for Capital Assets themselves.
These are maintained in a Schedule of Capital Assets.
Chapter 6
• Governments must maintain capital projects funds for
resources that are legally restricted , committed, or
assigned to expenditure for capital outlays .
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Capital Equipment Replacement Fund (CPF)
Cash
$1,000,000
Other financing sources
1,000,000
Government-Wide Governmental Activities None
Granof & Khumawala-6e
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
$1,000,000
Cash
1,000,000
Chapter 6
CPF: Capital Assets- Acquisition
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Three Phases:
 Phase 1: Preconstruction Phase
--Project & Financing authorization
 Phase 2: Construction Phase
 Phase 3: Debt Servicing Phase
Chapter 6
CPF: Capital Assets-Construction
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o 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)
Granof & Khumawala-6e
Financing
Acquire extensive, long-term financing (3 types)
• Type I - Tax Supported Debt
Chapter 6
Phase 1: Preconstruction Phase
Project & Financing authorization
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Granof & Khumawala-6e
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.
o Premiums and discounts.
Chapter 6
Type I Tax Supported Debt
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Type I - Example
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
Granof & Khumawala-6e
Capital Projects Fund:
Dr.
Cr.
Cash
$5,050,000
Other Financing Sources-Bond proceeds
5,000,000
Other Financing Sources-Bond premium
50,000
Chapter 6
Assume that bonds with a face value of $5,000,000 were
issued at 101 to finance the project.
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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.
Dr.
$100,000
Due from Other Governmental Units
$100,000
Program Revenues-Capital Grants and
Contributions-General Government
Cr.
100,000
Granof & Khumawala-6e
Capital Projects Fund:
Due from other Governmental Units
Revenues
Govt.-wide (Gov’tal. Activities)*:
Chapter 6
Upon approval, the following journal entry would be made:
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)
Gov’t.-wide (Govtal. Activities)*:
Same entry.
*Note:This entry is not made on the books, this is the
conversion at
the eoy
Granof & Khumawala-6e
Capital Projects Fund:
Dr.
Cr.
Cash
$100,000
Due from Other Governmental Units
100,000
Chapter 6
The amount due from the federal government for the
previously recorded capital grant was received in full
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Granof & Khumawala-6e
Overview
Most Common: Special Assessments
--Levied when taxpayers in areas beyond their
jurisdiction want to benefit from certain facilities and
services.
Chapter 6
Type III – Other Forms of Financing
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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.
Chapter 6
Additional Topics – CPFs
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Gov’t.-wide (Gov’tal. Activities):
No entry needed.
Granof & Khumawala-6e
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
$50,000
Due to General Fund
50,000
Chapter 6
Interim Financing - Example
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Interim Financing Example (cont’d)
Dr.
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
Granof & Khumawala-6e
Capital Projects Fund:
Due to General Fund
Cash
Chapter 6
The $50,000 due to the General Fund was repaid.
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o GASB requires budgeting over integrated funds when control
cannot be established by other means (e.g. fixed-price
contracts)
Granof & Khumawala-6e
• 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.
Chapter 6
Budgeting
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Capital Projects Fund:
Encumbrances
Reserve for Encumbrances
Dr.
Cr.
$50,000
50,000
Granof & Khumawala-6e
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.
Chapter 6
Budgeting Example (cont’d)
Government-wide (Gov’tal. Activities):
No entry needed.
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Capital Projects Fund:
Construction Expenditures
Reserve for Encumbrances
Cash
Encumbrances
Dr.
$48,000
50,000
Cr.
48,000
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
Granof & Khumawala-6e
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.
Chapter 6
Budgeting Example (cont’d)
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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
o Taxes levied by DSF
o Taxes levied by GF and transferred to DSF
o Special taxes restricted to the payment of debt
3) Other means of financing
o Special assessments
*2) Grants would not have debt to service
Granof & Khumawala-6e
•
Chapter 6
Debt Service Funds(DSF) - Overview
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DSFs - Overview (cont’d)
GASB requires DSFs be established when:
GASB recommends:
• A single DSF for all debt serviced by property taxes
• Governments hold number of funds to a minimum
Granof & Khumawala-6e
• Financial resources are being accumulated for
principal and interest payments maturing in future
years.
Chapter 6
• Legally required, or
Refer to the comprehensive example on pgs. 238-241.
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Granof & Khumawala-6e
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
Chapter 6
DSFs - Overview (cont’d)
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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.
Granof & Khumawala-6e
Assume 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.
Chapter 6
DSF - Example
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Type I - Tax Supported Debt
Overview: Two Types
2) Term bonds
Granof & Khumawala-6e
• Regular serial bonds
• Deferred Serial bonds
Chapter 6
1) Serial bonds:
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1) Serial Bonds - Overview
o Advantage: Self-amortizing; no sinking fund needed
Granof & Khumawala-6e
• 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.
Chapter 6
• Principal matures in annual installments.
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Gov’t.-wide (Gov’tal. Activities):
Cash
Serial Bonds Payable – 6%
Dr.
Cr.
$100,000
Granof & Khumawala-6e
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.
Chapter 6
Serial Bonds DSF - Example
100,000
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Debt Service Fund:
Estimated Other Financing Sources
Appropriations
Due from General Fund
Interfund Transfers In
Government-wide (Gov’tal. Activities):
No entry needed.
Dr.
$11,000
Cr.
11,000
11,000
11,000
Granof & Khumawala-6e
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.
Chapter 6
Serial Bonds DSF - Example (cont’d)
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Serial Bonds DSF - Example (cont’d)
Govt.-wide (Gov’tal. Activities):
No entry needed.
Granof & Khumawala-6e
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)
Chapter 6
On May 28, 2014, the transfer from the General Fund was received.
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Serial Bonds - Example (cont’d)
Dr.
$3,000
Cr.
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
Granof & Khumawala-6e
Debt Service Fund:
Expenditures-Bond Interest
Cash
Chapter 6
The June 1, 2014, interest payment was made on
schedule.
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Serial Bonds - Example (cont’d)
Granof & Khumawala-6e
Debt Service Fund: (11/29/14)
Dr.
Cr.
Cash
$8,000
OFS-nonreciprocal transfer from the GF
8,000
12/01/14
Expenditures—Bond Principal
$5,000
Expenditures—Bond Interest
3,000
Cash
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
Chapter 6
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.
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Serial Bonds - Example (cont’d)
Closing entries on December 31, 2014:
Gov’t.-wide (Gov’tal. Activities)*:
Net Assets – Unrestricted
Interest Expense on Long-term Debt
Cr.
11,000
$11,000
5,000
6,000
$6,000
6,000
*Note: This entry is not made on the books, it is the conversion at
the eoy
Chapter 6
Appropriations
Expenditures—Bond Principal
Expenditures—Bond Interest
Dr.
11,000
Granof & Khumawala-6e
Debt Service Fund:
Interfund Transfers In
Estimated Other Financing Sources
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Granof & Khumawala-6e
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
Chapter 6
Term Bonds-Overview
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Type III – Other Forms of Financing
• 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.
Granof & Khumawala-6e
Fund Statements
Chapter 6
Special Assessments - Overview
--benefits only a select group of individuals
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Special Assessments-Overview(cont’d)
Governments may or may not be obligated to account for special
assessment debt (both interest and principle)
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.
Granof & Khumawala-6e
• 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, or
o t is legally liable for assuming the debt or gives indication
that it may honor the debt in the event of default.
Chapter 6
OBLIGATED:
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Granof & Khumawala-6e
• 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.
Chapter 6
Special Assessments - Overview
(cont.)
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Special Assessments - Example
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
Dr.
$180,000
Granof & Khumawala-6e
Debt Service Fund:
Assessments Receivable—Current
Assessments Receivable—Deferred
Revenues
Deferred Revenues
Chapter 6
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.
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:
Cr.
180,000
Early next year, the following reclassification entries would be made:
Debt Service Fund:
Assessments Receivable—Current
Assessments Receivable—Deferred
Dr.
$100,000
Deferred Revenues
Revenues
$100,000
Cr.
100,000
Chapter 6
Dr.
$100,000
80,000
Granof & Khumawala-6e
Debt Service Fund:
Expenditures—Bond Principal
Expenditures—Bond Interest
Cash
100,000
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2 Provisions to prevent arbitrage abuse:
• Arbitrage restrictions.
--State and local governments must observe arbitrage regulations.
Granof & Khumawala-6e
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.
Chapter 6
Additional Topics
• 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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o Example in text (p. 249-251) shows there is no real
economic gain or loss from refunding debt
o 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)
Granof & Khumawala-6e
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
Chapter 6
Debt Refunding
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”
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Debt Refunding Transactions
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.
Granof & Khumawala-6e
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 SourcesProceeds of refunding (new) Bonds
100,000
Chapter 6
• Bond refunding
• Refinance
• General rule
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Debt Refunding Transactions (cont’d)
Dr.
$100,000
Cr.
100,000
(Note: Report only the new issue as debt in governmental activities)
Granof & Khumawala-6e
Debt Service Fund:
Other Financing Uses—Refunded Bonds
Cash
Chapter 6
Assuming old bonds are retired shortly after issue of
refunding bonds
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Granof & Khumawala-6e
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. 251-252
Chapter 6
In-Substance Defeasance
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In-Substance Defeasance (cont’d)
• Amortize loss (or gain) over future years using the
shorter of the original term or the term of the new debt.
Granof & Khumawala-6e
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 “riskfree” like US Treasury Bonds
Chapter 6
• In-substance defeasance should satisfy the following
conditions:
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Summary
• Capital Projects and Debt Service Fund are accounted for on a
modified accrual basis.
• 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.
Granof & Khumawala-6e
• Special Assessments are accounted for just as any other capital
projects.
Chapter 6
• 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.”
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