Chapter 6: The Governmental Fund Accounting Cycle

Capital Projects Funds, Debt Service Funds, and Permanent Funds

Multiple Choice

1. What is the purpose of a Debt Service Fund?

a. to account for resources that are restricted or otherwise limited to pay the
debt service on all debt of the government, including Enterprise fund debt
and short-term debt used to finance General Fund operations
b. to account for resources that are restricted or otherwise limited to pay
principal and interest on general long-term debt
c. to account for resources that are restricted or otherwise limited to pay the
debt service on all long-term debt of the government, and also to show how
much long-term debt is outstanding
d. to provide a means of reporting all outstanding long-term debt of the
government in a single location

Answer: b

2. At what point should interest be recognized as an expenditure in a Debt Service

Fund?
a. when it accrues
b. when it is paid
c. when it is due and payable
d. when the bonds resulting in payment of interest are issued

Answer: c

3. A city sells $5 million of 20-year general obligation bonds on October 1, 2013.

Interest on the debt is payable at the rate of 5% a year on the unpaid balance of the
debt, every six months commencing March 31, 2014. How much should the city
report as an interest expenditure in the Debt Service Fund for the calendar year
ending December 31, 2013?
a. $0
b. $30,000
c. $60,000
d. $120,000

Answer: a
 4. A city sells $15 million of general obligation bonds on October 1, 2013. The bonds
mature at the rate of $1 million a year each September 30, starting September 30,
2014. The amount due September 30, 2014 is paid. How much should the city
report as outstanding debt in the Debt Service Fund in its year-end fund level
financial statements on December 31, 2014?
a. $15,000,000
b. $14,000,000
c. $13,750,000
d. $0

Answer: d

5. A city sells $5 million of 6% ten-year general obligation bonds on April 1, 2013. The
first installment of debt principal ($250,000) is due to be paid on September 30,
2013. What entry should the city make on September 30, 2013 in the Debt Service
Fund regarding the bond principal?
a. It should recognize a $250,000 liability for Matured bonds payable.
b. It should reduce the $5 million long-term liability by $250,000.
c. It should do nothing in the Debt Service Fund, but it should reduce Bonds
payable by $500,000 in the Capital Projects Fund
d. It should make no entry anywhere until the principal is actually paid.

Answer: a

6. A city keeps its books on a calendar year basis. On April 1, 2013, the city sold
$500,000 of 6% general obligation bonds, payable in semi-annual installments. The
first installment, due October 31, 2013 covered interest of $15,000 and principal of
$25,000. For the year ended December 31, 2013, how much should the Debt
Service Fund report as expenditures?
a. $15,000
b. $40,000
c. $15,000, plus an accrual for three months' interest
d. $40,000, plus an accrual for three months' interest and principal

Answer: b

7. What kinds of expenditures are accounted for in Debt Service Funds?

a. only the principal payments on general obligation long-term debt
b. only the interest expenditures on general obligation long-term debt
c. both principal payments and interest expenditures on general obligation
long-term debt
d. all debt service on all governmental debt, regardless of the purpose of the debt

Answer: c
 8. A state issues long-term debt to finance a major construction project. The first
installment of debt service requires payment of principal of $75,000 and interest of
$100,000. Which of the following statements is true on the day that payment for
principal and interest is legally due?
a. expenditures of $175,000 should be recognized in the debt service fund.
b. expenditures of $75,000 should be recognized in the capital projects fund
and expenditures of $100,000 should be recognized in the debt service fund.
c. expenditures of $100,000 should be recognized in the debt service fund and
bonds payable should be reduced by $75,000 in the debt service fund.
d. expenditures of $175,000 should be recognized in the debt service fund and
bonds payable should be reduced by $75,000 in the capital projects fund.

Answer: a

9. In what circumstances are Debt Service Funds required to be used in governmental

accounting?
a. a legal requirement dictates that a Debt Service fund be established
b. a government is currently accumulating resources for the payment of
principal and interest on long-term debt in future years
c. a government issues general obligation bonds
d. both a and b
e. both a and c

Answer: d

10. In what circumstance is a Capital Projects Fund required to be used in governmental

accounting?
a. to record the acquisition or construction of all capital assets
b. to record the acquisition or construction of any capital asset that is not
recorded in an Enterprise Fund
c. when capital projects are at least partially financed by general obligation
bond proceeds
d. to record the acquisition or construction of all major capital assets, except
infrastructure assets

Answer: c

11. Accrued interest on the following type of debt is reported in a governmental fund:
a. short-term tax anticipation notes payable
b. serial bonds
c. general obligation bonds
d. long-term bank notes

Answer: a

12. Which of the following groups of accounts best describes the types of assets and
liabilities likely to be found in Capital Projects Funds?
a. cash, investments, construction contract payable, matured bonds payable
b. cash, buildings, equipment, construction contracts payable
 c. cash, investments, construction contracts payable, vouchers payable, long-
term debt payable
d. cash, investments, retainage payable, vouchers payable

Answer: d

13. A city accounts for its capital acquisitions using encumbrances. When the city enters
into a contract to acquire equipment, what journal entry should it make?
a. debit expenditures - capital outlay; credit vouchers payable
b. debit encumbrances; credit budgetary fund balance reserved for encumbrances
c. debit equipment; credit vouchers payable
d. debit encumbrances; credit appropriations - equipment

Answer: b

14, 15, and 16. The following set of facts applies to questions 14, 15, and 16: A state constructs an
office building. The construction is financed with: (1) a transfer of $1 million from the General
Fund; (2) a grant of $2 million from the federal government; (3) bond proceeds of $7 million; and
(4) earnings of $100,000 from temporary investment of bond proceeds. All transactions occur in
one year.

14. Based on the preceding set of facts, how much should be reported as Revenues in
the Capital Projects Fund?
a. $100,000
b. $2,100,000
c. $3,100,000
d. $8,100,000

Answer: b

15. Based on the preceding set of facts, how much should be reported as Other
financing sources in the Capital Projects Fund?
a. $1,000,000
b. $3,000,000
c. $8,000,000
d. $10,000,000

Answer: c

16. Based on the preceding set of facts, what should be reported in the financial
statements of the General Fund for the year?
a. other financing uses of $1 million
b. expenditures of $1 million
c. other financing sources of $2 million and other financing uses of $1 million
d. revenues of $2 million and other financing sources of $7 million
Answer: a

17. A city issues $5 million of long-term general obligation bonds to construct a new fire
house. How and where should that transaction be recorded?
a. as an other financing source in the debt service fund
b. as a liability in the capital projects fund
c. as a liability in the debt service fund
d. as an other financing source in the capital projects fund

Answer: d

18. What does the account, retainage payable, represent in the financial statements of a
Capital Projects Fund?
a. a long-term liability
b. an amount owed to other governments because capital grant provisions were not met
c. an amount held back by a government when paying a contractor
d. an amount that can be reported in the General Fund, but not a Capital Projects Fund

Answer: c

19. A city acquired two vehicles in a particular year: (1) a sedan for $20,000 that was
paid for through the General Fund and (2) a sanitation truck for $125,000 that was
paid for through the Capital Projects Fund. How should the assets be reported in the
city's fund-level financial statements?
a. $145,000 should be reported as assets in the general fund
b. $20,000 should be reported as assets in the general fund and $125,000
should be reported as assets in the capital projects fund
c. $145,000 should be reported as assets in the capital projects fund
d. neither acquisition should be reported as assets in the fund-level financial
statements

Answer: d

20. Which of the following fund types is most likely to have the shortest "life"?
a. internal service
b. capital projects
c. enterprise
d. special revenue

Answer: b

21. A city constructs a new building by issuing debt in the amount of $3 million. How
should the city report the debt proceeds in its Capital Projects Fund statement of
revenues, expenditures, and changes in fund balance?
a. as a revenue
b. as an other financing source
c. as a liability captioned general long-term obligations
d. as a liability captioned due to the debt service fund

Answer: b
22. Depending on the restrictions placed on resources used to acquire a police car, the
acquisition of the car could be reported in which of the following funds?
a. general fund
b. special revenue fund
c. capital projects fund
d. all of the above
e. none of the above

Answer: d

23. How should a fixed asset acquired through a capital lease agreement be recorded in
a General Fund?
a. at the present value of the future lease payments, by debiting expenditures
and crediting other financing sources - capital leases
b. at the total amount of the future lease payments, by debiting expenditures
and crediting other financing sources - capital leases
c. at the present value of the future lease payments, by debiting expenditures
and crediting capital leases payable.
d. no entry is needed until payments are actually made on the capital lease
agreement.

Answer: a

24. A city acquires equipment on January 1, 2013 by means of a capital lease agreement.
The agreement calls for paying the leasing company $300,000 in three $100,000
annual payments, starting December 31, 2013. The present value of the three lease
payments, using a 6% interest rate, is $267,300. The city will make the lease
payments from the General Fund. What journal entry should the city make on
January 1, 2013 in the Fund?
a. debit expenditures - capital outlay; credit other financing sources, for
$300,000
b. debit expenditures - capital outlay; credit other financing sources, for
$267,300
c. debit capital assets; credit capital leases payable, for $300,000
d. debit expenditures - capital outlay; credit capital leases payable, for
$267,300

Answer: b

25. A Debt Service Fund accumulates resources to retire debt that is due in a lump sum
in the year 2014. The Fund held marketable securities that cost $900,000 when
purchased during 2006 and 2007. The securities had fair market values of $875,000
on January 1, 2013, and $930,000 on December 31, 2013. The average fair market
value during the year was $895,000. At what amount should the Fund report the
securities in its balance sheet on December 31, 2013?
a. $875,000
b. $895,000
c. $900,000
d. $930,000

Answer: d
26. The operations of a debt service fund generally are controlled by which of the
following mechanisms?
a. bond indentures
b. encumbrance accounting
c. legislative oversight and review
d. break-even analysis

Answer: a

27. Capital assets that were financed through governmental fund activities will appear in
which financial statement?
a. government-wide statement of net assets
b. capital projects fund balance sheet
c. debt service fund balance sheet
d. enterprise fund balance sheet

Answer: a

28. Retainage payable will most likely appear in which financial statement?
a. government-wide statement of net assets
b. capital projects fund balance sheet
c. debt service fund balance sheet
d. special revenue fund balance sheet

Answer: b

29. The largest dollar amount of resources flowing into a capital projects fund normally will
come from
a. dedicated property taxes
b. user charges
c. bond proceeds
d. interest on investments

Answer: c

30. The largest dollar amount of resources flowing into a general obligation debt service
fund normally will come from
a. tax revenues and interfund transfers
b. interest on investments and user charges
c. fiscal agent fees and fines
d. liquidation of encumbrances

Answer: a

31. What type of fund is most likely used to account for the spending of income earned
by a Permanent Fund?
a. agency fund
b. private-purpose trust fund
c. enterprise fund
d. special revenue fund
Answer: d

32. Which of the following is a characteristic of a Permanent Fund?

a. both the corpus of the fund and its earnings must be kept intact permanently.
b. permanent funds are created to support programs that benefit other
governmental units.
c. earnings of a permanent fund are used to support programs that benefit the
government or its citizens.
d. permanent Funds are established when a government receives a bequest
without a legal trust agreement.

Answer: c

33. How should marketable securities be valued when reported in a Permanent Fund’s
balance sheet?
a. at the cost to the donor of the investments
b. at the fair value of the investments on the date received by the government
c. at the fair value of the investments as of the balance sheet date
d. at the amount paid to acquire the securities

Answer: c

34. A capital project is completed, but $500,000 remains in a capital projects fund. How
should the government use the $500,000 remaining in the capital projects fund?
a. the government should retain the remaining funds in the capital projects fund
for a potential future capital project
b. the government should consult provisions of relevant grant and bond issues,
which may provide guidance regarding its use
c. the first-in, first out basis
d. residual amounts in a capital projects fund after completion of a project must
be transferred to a debt service fund

Answer: b

35. A government may have arbitrage when:

a. it finances capital projects through federal grants
b. it borrows money at lower tax-exempt rate, but invests it at a higher rate
c. it pays a higher rate on its tax-exempt debt than the rate that it receives from
its investments
d. its debt pays a lower rate of interest than federally issued debt of the same
credit quality

Answer: b

Problems

36. (Classification of resource inflows in Fund operating statements)

A county's Debt Service and Capital Projects Funds had the following resource
inflows during 2013. State whether each of the inflows should be reported as
revenues or as other financing sources in the fund-level statements of revenues,
expenditures and changes in fund balances.
 a. Property taxes levied specifically for the Debt Service Fund
b. Cash received from General Fund to finance debt service payments
c. Cash received from General Fund to finance part of the cost of new police
headquarters
d. Grant from state to finance part of cost of new police headquarters
e. Proceeds of bonds issued to finance part of the cost of new police
headquarters
f. Interest earned on investment of resources being accumulated to finance
construction
g. Increase in fair market value of investments being accumulated to finance
construction
h. Bond premium received by Debt Service Fund from Capital Projects fund

Answer:
a. Revenues
b. Other financing sources
c. Other financing sources
d. Revenues
e. Other financing sources
f. Revenues
g. Revenues
h. Other financing sources

37. (Basic journal entries for acquisition of capital assets through issuance of debt)

Prepare entries to record the following transactions related to acquisition of capital

assets by a county. The county does not use encumbrance accounting. Identify the
fund(s) used.

a. The county issues general obligation bonds in the amount of $900,000,

receiving cash for the full face amount of the bonds. The cash will be used to
buy capital assets.
b. The county buys a prefabricated building for $750,000, using part of the
bond proceeds. The building is delivered and the invoice for the building is
approved.
c. The invoice approved in b. is paid.
d. The General Fund transfers cash of $55,000 to another fund in anticipation
of the payment of the first installment of interest ($30,000) and principal
($25,000) on the debt.
e. The first installment of debt service on bonds issued in a. becomes due and
payable.
f. Debt service on the bonds issued in a. is paid.

Answer:
a. CPF
Cash 900,000
 Other financing source – long-term debt issued 900,000

b. CPF
Expenditures - building 750,000
Vouchers payable 750,000

c. CPF
Vouchers payable 750,000
Cash 750,000

d. GF
Transfer out to Debt Service Fund 55,000
Cash 55,000

DSF
Cash 55,000
Transfer in from General Fund 55,000

e. DSF
Expenditures - bond principal 25,000
Expenditures - interest 30,000
Matured bonds payable 25,000
Matured interest payable 30,000

f. DSF
Matured bonds payable 25,000
Matured interest payable 30,000
Cash 55,000

38. (Journal entries with emphasis on Capital Projects Fund)

Prepare journal entries in the Capital Projects Fund to record the following
transactions related to the construction of a building by the Village of Navajo Falls.
(Note that only Capital Projects Fund journal entries are required.) The Village
adopts a formal budget and uses encumbrance accounting.

a. The Village Council adopts a capital budget at the beginning of the year. To
finance construction of the building, the Village will transfer $3 million from
its General Fund and apply for a state grant of $1 million. It appropriates $4
million for construction.

b. The General Fund transfers $3 million to the Capital Projects Fund for the
new project.

c. The state approves Navajo Falls's application for a $1 million construction

grant and simultaneously sends a check to the Village. The grant is
expenditure driven and thus requires that Navajo Falls incur qualifying
expenditures.

d. Navajo Falls awards a construction contract in the amount of $3.4 million.

 e. The contractor sends a progress billing to Navajo Falls in the amount of
$1.6 million. The bill is approved by the Village's engineers and a voucher is
prepared, less a 10% retainage pending completion of the building and final
approval by the Village. Navajo Falls considers 25 percent of the billing to
be the state's share of the cost.

f. The voucher in e., above, is paid.

g. The contractor encounters construction problems due to unforeseen soil

conditions. As a result, Navajo Falls authorizes a change order increasing the
cost of the construction contract by $200,000.

h. The contractor completes construction, and sends Navajo Falls an invoice

for the remaining $2 million. The Village's engineers inspect the building and
accept the work. The invoice is approved and paid, together with the
amount retained on the progress billing in e., above. Navajo Falls considers
$600,000 of the billing to be the state's share of the cost.

Answer:
a. Estimated other financing sources 3,000,000
Estimated revenues 1,000,000
Appropriations 4,000,000

b. Cash 3,000,000
Transfer in from General Fund 3,000,000

c. Cash 1,000,000
Advance on construction grant 1,000,000

d. Encumbrances 3,400,000
Budgetary fund balance reserved for encumbrances 3,400,000

e. Budgetary fund balance reserved for encumbrances 1,600,000

Encumbrances 1,600,000

Expenditures - construction costs 1,600,000

Construction contracts payable 1,440,000
Retainage payable 160,000

Advance on construction grant 400,000

Revenues - construction grant 400,000

f. Construction contracts payable 1,440,000

Cash 1,440,000

g. Encumbrances 200,000
 Budgetary fund balance reserved for encumbrances 200,000

h. Budgetary fund balance reserved for encumbrances 2,000,000

Encumbrances 2,000,000

Expenditures - construction costs 2,000,000

Construction contracts payable 2,000,000

Construction contracts payable 2,000,000

Retainage payable 160,000
Cash 2,160,000

Advance on construction grant 600,000

Revenues - construction grant 600,000

39. (Journal entries with emphasis on Debt Service Fund)

The Shannon Township Debt Service Fund accumulates resources to pay its $2
million general obligation debt. The debt is payable in equal annual installments of
principal over 10 years with 5% interest on the unpaid principal. Prepare journal
entries to record the following transactions in the Debt Service Fund.

a. The Township levies a special property tax amounting to $500,000 to pay

debt service on its long-term general obligation debt. The tax must be
accounted for in the Debt Service Fund.
b. All the property taxes levied for debt service purposes are collected.
c. The Township invests $150,000 in a six-month certificate of deposit.
d. Debt service (interest of $100,000 and principal of $200,000) becomes due
and payable.
e. The debt service liabilities are paid.
f. The certificate of deposit in c. matures and the Township receives a total of
$153,000, which includes $3,000 of interest.

Answer:
a. Property taxes receivable 500,000
Revenues - property taxes 500,000

b. Cash 500,000
Property taxes receivable 500,000

c. Investments 150,000
Cash 150,000

d. Expenditures - bond principal 200,000

Expenditures - interest 100,000
Matured bond principal payable 200,000
Matured bond interest payable 100,000
 e. Matured bond interest payable 200,000
Matured bond interest payable 100,000
Cash 300,000

f. Cash 153,000
Investments 150,000
Revenues – interest earned on investments 3,000

40. (Journal entries to record a capital lease transaction)

A town enters into a lease-purchase agreement with Trucks, Inc. to acquire four
garbage trucks. The agreement provides that the town pay $100,000 at the end of
each year for four years. Upon full payment, the trucks become town property. The
agreement is based on an interest rate of 7%. (The present value of an annuity of $1
for 4 periods at 7% is 3.3872.) The lease agreement is accounted for in the General
Fund.

Required:
Prepare journal entries for the General Fund to record (a) the lease agreement and
the lease payment (b) at the end of the first year and (c) at the end of the second
year.

Answer:
(a) Record lease agreement
Expenditures - capital outlay 338,720
Other financing sources - capital leases 338,720

(b) Lease payment at end of first year

Expenditures - capital lease principal 76,289
Expenditures - capital lease interest 23,711
Cash 100,000

(c) Lease payment at end of second year

Expenditures - capital lease principal 81,630
Expenditures - capital lease interest 18,370
Cash 100,000

Note - The present value of the lease is $100,000 x 3.3872 or $338,720. Interest for the first year is
$338,720 x .07 = $23,711; and payment on principal is the difference between the $100,000 cash
payment and the interest of $23,711. After the payment, the "outstanding debt" is the difference
between the original debt of $338,720 and payment of $76,289, or $262,431. Therefore, the second
year's interest is $262,431 x .07= $18,370, and the payment on principal is $81,630. (This problem
could be varied by asking the student to prepare a schedule showing the principal and interest
payments for the life of the lease.)

41. (Journal entries for a major construction project)

Prepare journal entries to record the following transactions of a state, identifying the
funds affected by each transaction. Record journal entries for all funds affected. The
state prepares a budget for the Capital Projects Fund and uses encumbrance
accounting in that fund.

a. The state records its capital budget. It appropriates $10 million for highway
construction, which will be financed entirely with the issuance of bonds.
b. The state sells 20-year 6% bonds having a face value of $10 million. The
bonds are sold at a discount, so the state realizes a total of $9,900,000.
Equal installments of principal will be paid every six months, together with
interest on the unpaid balance.
c. The state awards two contracts, one for highway construction ($6,500,000)
and one for construction supervision ($350,000). Both contracts provide for
progress payments. The highway construction contract provides for 10%
retainage pending completion of the project. There is no retainage on the
construction supervision contract.
d. The construction contractor submits an invoice for $1,500,000. The invoice
is approved and a voucher is prepared, less the 10% retainage.
e. The construction supervisor submits an invoice for $100,000, and a voucher
is prepared.
f. Both of the invoices in transactions d. and e. are paid.
g. The state transfers $800,000 from the General Fund to the Debt Service
Fund in anticipation of the payment of debt service on the bonds.
h. The first semi-annual debt service on the 20-year bonds becomes due and
payable (see transaction b).
i. The debt service is paid.

Answer:
a. CPF
Estimated other financing sources 10,000,000
Appropriations 10,000,000

b. CPF
Cash 9,900,000
Other financing use – bond issue discount 100,000
Other financing source - long-term debt issued 10,000,000

c. CPF
Encumbrances – capital project 6,850,000
Budgetary fund balance reserved for encumbrances 6,850,000

d. CPF
Budgetary fund balance reserved for encumbrances 1,500,000
Encumbrances – capital project 1,500,000

Expenditures - construction costs 1,500,000

Construction contracts payable 1,350,000
Retainage payable 150,000
e. CPF
Budgetary fund balance reserved for encumbrances 100,000
Encumbrances - capital project 100,000

Expenditures - construction supervision 100,000

Vouchers payable 100,000

f. CPF
Construction contracts payable 1,350,000
Vouchers payable 100,000
Cash 1,450,000

g. GF
Transfer out to Debt Service Fund 800,000
Cash 800,000

DSF
Cash 800,000
Transfer in from General Fund 800,000

h. DSF
Expenditures - bond principal 250,000
Expenditures - interest 300,000
Matured bonds payable 250,000
Matured interest payable 300,000

i. DSF
Matured bonds payable 250,000
Matured interest payable 300,000
Cash 550,000
42. (Preparing entries to close a Capital Projects Fund) [see p. 195… uses “close” not
“abolish”]

You are the Finance Director of the Town of Blue Mountain. Presented below is the
trial balance for a Capital Projects Fund of the Town at October 31, 2013. The
Town Engineer has advised you that the project accounted for within this fund, a
new system of bicycle trails, is complete and formal acceptance by the Town is
pending. The Town Council has directed you to abolish this fund and transfer any
remaining net assets to the Town’s Debt Service Fund. Prepare the entries necessary
to settle the remaining liabilities of the fund, close the accounts, and transfer the
remaining net assets to the Debt Service Fund.
.
Town of Blue Mountain
Capital Projects Fund
Preclosing Trial Balance
October 31, 2013
Debits Credits
Cash $ 70,160
Vouchers payable $ 24,450
Retainage percentage 42,750
Restricted fund balance 117,285
Revenues - interest 50,175
Expenditures - capital outlay 197,000
Transfer in from General Fund 32,500
$ 267,160 $ 267,160
Answer:
Vouchers payable 24,450
Retainage payable 42,750
Cash 67,200

Revenues - interest 50,175

Transfer in from General Fund 32,500
Restricted fund balance 114,325
Expenditures - capital outlay 197,000

Transfer out to Debt Service Fund 2,960

Cash 2,960
Restricted fund balance 2,960
Transfer out to Debt Service Fund 2,960