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UNIT 5:

5 DEBT SERVICE FUND

Contents
5.0 Aims and Objectives
5.1 Introduction
5.2 General Outline of Debt Service Funds
5.3 Types of Long Term Debts
5.4 Numbers of Debt Service Fund
5.5 Budgeting for Debt Service Fund & Services of Finance
5.6 Use of General Fund to Account for Debt Service
5.8 Accounting for Serial Bonds Debt Service Funds
5.9 Summary
5.10 Answers to Check Your Progress Questions

5.0 AIMS AND OBJECTIVES

This chapter aims at how governmental units long-term liabilities are serviced and how such
debt servicing activities are accounted in a separate fund. Debt service funds accounts both
payment of interest and principal when due. Long term Debt incurred to provide money to
pay for the construction or acquisition of Fixed Assets or for any other purposes can be
repaid only from revenue raised in subsequent years to service the debt. Revenue raised
from Taxes or special assessments for debt service and expenditure for debt service are
commonly accounted for by use of debt service fund; the subject of this topic. after going
through this unit, the student be able to;

1. describe how General long Term debt is serviced through the Debt Service Fund
2. understand the types of long term Debt and their character in Governmental
Accounting.
3. describe the accounting and related issues in servicing governmental unit’s General long
Term Debt

5.1 INTRODUCTION

From time to time governmental entities have a shortage of cash to carry out their
activities. In such cases, governmental entities may turn to borrowing to supply the needed
cash. This especially is true when cash is needed for capital projects. The size of the project
typically means that cash cannot be easily obtained by taxes or other means of generating

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revenue. When money is borrowed therefore, there should be plan to repay it and the
resources which have been designated to repay the debt with its interest should not be used
for any other purpose. For the purpose of administering the repayment plan and to keep
separate resources designated for the payment of the debt and its interest, the debt service
fund is created.

5.2 GENERAL OUTLINE OF DEBT SERVICE FUND

Characteristics
1. Debt service fund is used to account for both the repayment of the principal and payment
of interest of the long-term debt when they are due. Often Debt service funds are legally
mandated. Other times, the government administrator might think a
Debt Service Fund is useful for management of resources being accumulated for Debt
Service.
2. DSF are governmental funds and therefore are Expendable. Although, like a CPF, they
have focus more than a year. Debt service funds are for general long-term debt (GLTD),
which has been used to provide resources for one of the other governmental fund types.
Often they arise from the Capital projects. Proprietary funds also borrow on along term
basis, but their repayment is accounted for in the proprietary fund itself rather than a
separate debt service fund.

3. As expendable funds, DSF use the modified accrual basis of accounting. An application
of modified accrual, which is of special interest to DSF, has to do with interest payable.
Interest payable is not accrued in the DSF. It is only recorded as a liability in the period
when it becomes due. For example, interest due on January 31, 20x1 would not be accrued
and recorded on December 31, 20 x 0 Balance Sheet.
4. Accounts recommended for use by a serial bond Debt service fund is similar with
that of General Fund and Special Revenue fund. Even if it is not exactly the same
such as budgetary accounts (Estimated Revenue, Estimated Other Financing
Sources, Appropriations, Estimated Other financing Uses) or proprietary accounts
(Revenues, OFS, Expenditures, OFU)

5. The operations of DSF do not involve the use of purchase orders and contracts for
goods and services. So the Encumbrance accounting is not needed.
6. The ledger accounts of a Serial Bond Debt Service fund includes liquid assets and
current liabilities and Fund Balance Accounts. Liquid Assets of serial Bond Debt Service

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funds are held for the purpose of paying interest or outstanding bonds and retiring the
principal instalment s as they fall due; for the convenience of the bond holders, the payment
of interest and the and the redemption of matured bonds is ordinarily handled through the
Banking system. usually the government designate a bank as a “Paying
“Paying Agent”
Agent” or a
“Fiscal Agent”
Agent” to handle interest and principal payments for each issue. The assets of a
Debt service Fund may therefore include Cash With paying Agent and the
appropriations, Expenditures and liabilities may include Amounts for the Services and
Charges for Paying Agents.

Investment Management may be performed by governmental employees or by banks,


brokers or others who charge for the service, Investment management fees are legitimate
charges against Investment Revenues.

7. Timing of Debt Service payments - mostly due to both political and financial
management considerations, the payment should be kept consistent over the life of the
issue. With serial bonds this is easy but with term bonds, it takes planning (the type of long
term bonds will be discussed later in this topic).

5.3 TYPES OF LONG TERM DEBTS

Bond- A written promises to pay a specified principal sum at a specified future date with
interest. They are typically issued in 1000 and 5000 denominations. All long term debts of
governmental units consists of one of the following two basic types of bonds;.

Term Bonds-
Bonds- term bonds are bonds whose principal is repaid in lump-sum at their maturity
date. Such lump-sum payment is usually made possible through accumulation of money in
the DSF on an actuarial basis over the life of the bond issue in a sinking fund.

Serial Bonds - this are bonds, which have periodic maturities.


maturities. the principal of a serial bond
so repaid at various ore determined dates over the life of the issue. There are four types of
serial bonds;

1. Regular Serial Bonds- The total Principal amount of an issue is repayable in a specified
number of equal annual instalments over the life of the issue.
2. Differed Serial Bond- The total principal amount of the issue is repaid in equal annual
instalments, but the first instalment is delayed for a period more than one year.
3. Annuity Serial Bond- if the amount of annual principal repayment is scheduled to

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increase each year by approximately the same amount that interest payments decrease
(interest decrease of course, because the amount of outstanding bond decreases) so that the
total DSF remains reasonably level over the term of the issue, the bonds are called
Annuity Serial Bonds.

4. Irregular Serial Bonds- these types of serial bonds may have pattern of repayment that
does not fit the other three categories.

Generally, there are other type of long-term debts (bonds) which also arise because of
different activities of Governmental units. This long term debts may or may not be
accounted for under DSF for their repayment. They maybe categorized as follows;

a. Revenue Bonds-
Bonds- are issued to finance the establishment or expansion of activities
accounted for in Enterprise Funds (EF). This bonds are shown as liabilities of EF.
Because their repayment and servicing can only come from money generated from
the operations of those funds.

b. General Obligation Bonds-


Bonds- this bonds serviced from the enterprise funds are also
issued to finance establishment or expansion of activities accounted for in EF. They bear
the full faith and credit of the governmental unit. When such bonds are to be repaid and
serviced from money generated from the operations of an EF, the bonds should be shown
as liabilities of the EF and as a contingent liability of the General Long Term Debt
Account Group (GLTDAG).

c. All other long-term debt fitting into one of the two preceding categories is shown
as a liability of the GLADAG. DSF is created for long-term debt that is shown as
a liability of the GLTDAG which is a self balancing group of accounts that keep
track of all unmatured long term debt in in group c above. DSF account for the
matured portion and the repayment of such principal and interest on such long term
debt.

In addition, to term bonds and serial bonds, debt service fund may be required to service
debts arising from the use of notes or warrants having a maturity period of more than a
year after the date of issue. Additionally, DSF may also be used to make periodic payments
required by capital lease agreements.

5.4 NUMBER OF DEBT SERVICE FUND

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Although each issue of long term or intermediate- term debt is a separate obligation and
may have legal restriction and servicing requirements that differ from other issues, GASB’s
standards provide that, if legally permissible a single debt service fund be used to account
for the services of all issues of tax supported and special assessment debt. if legal
restrictions do not allow the services of all issues of tax supported and special assessment
debt to be accounted for by a single Debt Service Fund. As few additional Debt Service
fund as is consistent with applicable laws should be created. Some accountants put all
General long term Debt in the same Debt Service fund; others prefer to have a separate
DSF for each bond issue legal requirements will no doubt affect which of these methods are
used. In this topic a separate debt service fund for each bond issue is illustrated simply as a
means for helping the reader focus on the different accounting procedures considered
appropriated for each kind of bond issue encountered in practice.

5.5 BUDGETING FOR DEBT SERVICE FUND AND SERVICES OF FINANCE

Sources of finances (resources)

1. Special Taxes- Special Taxes are not unusual when levied for servicing general long-
term debts. Sometimes a special tax is authorized with the issuance of bond -this is more
common with City Governments. the Tax itself could be accounted for in a Special
Revenue Fund, with periodic transfers to the DSF. if there is also a sufficient resources
available in the General Fund, periodic transfers can be made from it to the DSF. If taxes
are directly raised by the DSF, they are recognized as Revenues of the DSF. If the Taxes are
to be raised by another fund and transferred to the DSF, they must be recorded in OFS-
Operating transfer-Out in other fund accounts and OFS-Operating Transfer-In in the DSF.

2. Investments- for a term bond issue the assets that accumulate in the DSF will be
invested in income producing securities. the investment income is to be accounted in the
DSF as Revenue.

3. Refinancing- it may be possible to use the proceeds of the Sinking Fund.


Fund. (a means for
accumulating resources for a payment of a long Term Debt usually with Term Bonds) to
periodically purchase some of the outstanding bonds. If market interest fall later on, it may
be advisable to issue new bonds for the outstanding debt and use that money plus whatever
is in the sinking fund to retire the old Bonds. The process of issuing new bonds to pay of
the old ones is called Refinancing.

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4. Bond Premium and Accrued Interest on Bonds Sold- Depending upon the bond
indenture agreement, the DSF may be entitled to receive bond premium and Accrued
Interest on Debt Issue sold which are to be recognized as Revenues of DSF.

5. Residual Equity Transfers- If capital Projects are completed with Expenditures


less than Revenues and Other Financing Sources, The Residual Equity is ordinarily
transferred to the appropriate DSF.

Budgeting for Debt Service Fund

Whether or not additions to Debt service Funds are required by the Bond indenture to be
approximately equal year by year, good politics and good financial management suggest
that the burden on the tax payers be spread reasonably and evenly rather than lumped in the
years that issues or instalments happen to mature. If Taxes for payment of interest and
principal on long term debt are to be raised directly by the DSF, they are recognized as
revenues of the DSF. If Taxes are to be raised by another fund and transferred to the DSF,
they must be included in the Revenues budget oh the fund that will raise the revenue (often
the General Fund) and also budgeted by that fund as Operating transfer to the DSF. Since
the Debt Service fund is a budgeting and accounting entity it should prepare Revenues and
Other Financing Sources Budget that includes operating transfers from other fund. As well
as revenues it will raise directly from Earnings on its Investments.
Investments. Although the items may
be difficult to budget accurately, DSF can often account on receiving Premium on Debt
Issues Sold and Accrued Interest on Debt Issues Sold.
Sold. Premium and Accrued Interest on
Debt Issues Sold are considered Revenues of the recipient DSF. Similarly as indicated in
the previous chapter and on the shown on the services of finance previously, if Capital
projects are completed with expenditures less than Revenues and Other Financing Sources,
the residual Equity is ordinarily transferred to the DSF

The appropriations budget of a DSF must provide for the payment of all interest on
General long-term debt that will become legally due during the budget year, and for the
payment of any principal amounts that will become legally due during the budget year.
GASB standard currently require DSF accounting to be on the same basis as is required for
general and Special Revenue Funds. *** One peculiarity of the accrual basis used by the
governmental fund types which only relates to DSF is that, interests on long term debt is
not accrued. For Example:
Example: If the fiscal year of a governmental units ends on December 31,
20x5 and the interest on its bond is payable on January 1 and July 1of each year, the
amount payable on January 1, 20x6 would not be considered a liability in the Balance sheet

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of The Debt Service Fund prepared as of December 31, 20x5. The rationale for this
recommendation is that the interest is not
Legally due until January 1, 19x6. The same reasoning applies to principal amounts that
mature on the first day of the fiscal year.; they are not liabilities to be recognized in
statements prepared as of the day before. in the events 20x5 appropriations include January
1, 20x6 interest and /or principal payments, the appropriations expenditures(and resulting
liabilities) should be recognized in 20x5.

Persons budgeting and accounting for DSF should seek competent legal advice on the
permit table use of both premium on debt sold & residual equity transfer. In the some cases,
one or both of these items must be held for eventual debt repayment and may not be used
for interest payments. In other cases both Premium Revenue and Residual Equity Transfer-
In may be used for interest payments.

5.6 USE OF GENERAL FUND TO ACCOUNT FOR DEBT SERVICE

In some jurisdictions, laws does not require the Debt Service Fund function to be
accounted for by a debt service fund. Unless the Debt service function is very simple , it
may be argued that good financial management would dictate the establishment of a debt
service fund even though not required by law if neither law nor sound financial
administration require the use of debt service funds, the function may be performed within
the accounting and budgeting framework of the General fund. In such cases, the accounting
and the financial reporting standards discussed in this chapter should be followed for the
debt service activities of the General fund to the extent consistent with local laws.

5.7 ACCOUNTING FOR DEBT SERVICE FUNDS

Illustration

The town of X uses a Serial Bond Debt Service Fund to pay off matured bonds and -
-Interest payable amounts. Information about the Bond issue is as follows;

- Principal Amount ----------------- 1,000,000


- Interest Rate ---------------------- 10%
- Bonds Dated ---------------------- January 1, 20x6
- Interest Payable--------------------- January 1 and July 1, beginning July 1, 20x6
- Bonds mature serially at the arte of 100,000 a year starting January 1, 20x7.
- The Fiscal Period runs from July 1, 20x7 - June 30, 20x8.

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1. The Revenue Budget for Serial Bond Debt Service Funds for 20x8 consists of
estimated Revenues of 330,000 to be raised from Debt Service Tax Levy and
Estimated Revenues of 50,000 from earnings on investments.

=> Appropriation Budget includes matured interest payable and matured bonds
payable i.e ;

Interest for July 1 and January 1 = 900,000 x 5% x 2 = 90,000


Bonds payable mature January 1 = 100,000

Estimated Tax Revenue 330,000


Estimated Investment Revenue 50,000
Appropriations 190,000
Budgetary Fund Balance 190,000

2. Taxes receivable I the amount of 340,000 and estimated uncollectable taxes in the
amount of 10,000 are recorded.

Taxes Receivable- current 340,000


Allowance for uncollectable current taxes 10,000
Revenues 330,000

3. Half of the gross levy of taxes is collected in cash.

Cash 170,000
Tax Receivable-current 170,000

4. Interest payable on July 1, 20x7 is recorded as a liability.

Expenditure 45,000
Matured Interest Payable 45,000

5. Checks are written and mailed to the paying agent for the interest payment due on
July 1.

Cash With Fiscal Agent 45,000


Cash 45,000

6. Interest is paid by the Fiscal Agent and the Fiscal Agent fee of 500 is paid.

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Maturef Interest Payable 45,000
Expenditure 500
Cash With Fiscal agent 45,000
Cash 500
7. Taxes in the amount of 160,000 are collected.

Cash 160,000
Tax Receivable- Current 160,000
8. Cash of 100,000 is invested in a short term note which bear interest of 10%

Short Term Investment- Note 100,000


Cash 100,000

9. Interest on investment is received for the four months.

100,000 x 10% x 4/12 = 3333.33

Cash 3333.33
Revenue 3333.33

10. Checks are written and mailed to to the Fiscal Agent for the matured bonds and
interests due on January 1.

Cash with Fiscal Agent 145,000


Cash 145,000

11. On January 1, 20x8 matured bonds and interests of 145,000 and the Fiscal Agents fee
of 1,000 is charged as an Expenditure.

Expenditure 146,000
Matured Bonds Payable 100,000
Matured Interest Payable 45,000
F.Agent fee payable 1,000

12. Matured Bonds and interests is paid by the Fiscal Agent and the Fiscal Agent Fee
is paid.

Matured Bond Payable 100,000

100
Matured Interest Payable 45,000
Fiscal Agent Fee Payable 1,000
Cash With Fiscal Agent 145,000
Cash 1,000

13. Interest on Investment is received for three months.

100,000 x 10% x 3/12 = 2,500

Cash 2,500
Revenue 2,500

14. June 30, 20x8- Interest on investment are accrued for two months.

100,000 x 10% x 2/12 = 1666.67

Interest Receivable 1666.67


Revenue 1666.67

Town of X Serial Bond Debt Service Fund


Trial Balance
June30, 20x8

Account title Debit Credit

Cash 44,333.33
Short term Investment- Note 100,000
Interest Receivable 1,666.67
Tax Receivable 10,000
Allowance for Uncollectable Current Taxes 10,000
Unreserved and Undesignated Fund Balance -
Tax Revenue 330,000
Investment Revenue 7,500
Expenditure 191,500
Estimated Tax Revenue 330,000
Estimated Investment Revenue 50,000
Appropriation 190,000

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Budgetary Fund Balance . 190,000
Total 727,500 727,500

Town of X Serial Bond Debt Service Fund


Statement of Revenue, Expenditure and Change in Fund Balance
for the year ended June 30, 20x8
Favourable

Budget Actual Variance (Unfavourable)


Unfavourable)

Revenue:
Revenue:
Tax Revenue 330,000 330,000 -
Investment Revenue 50,000 7,500 (42,500)
Total Revenue 380,000 337,500 (42,500)
Expenditure 190,000 191,500 ( 1,500)
Excess of Revenue over Expenditure 190,000 146,000 (44,000)
Add: Fund Balance July 1, 20x7 - - -
Fund Balance June 30, 20x8 146,000

Town of X Serial Bond Debt Service Fund


Balance sheet
June 30, 20x8

Assets
Cash 44,333.33
Short Term Investment- Note 100,000
Interest Receivable 1,666.67
Tax Receivable 10,000
Less: Allowance for Uncollectable current Taxes 10,000 -
Total Assets 146,000 .

Liabilities and Fund Balance


Unreserved and Undesignated Fund Balance 146,000 .

Closing Entries

Appropriations 190,000
Budgetary fund Balance 190,000
Estimated Tax Revenue 330,000

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Estimated Investment Revenue 50,000

Tax Revenue 330,000


Investment Revenue 7,500
Expenditure 191,500
Unreserved and Undesignated-
Fund Balance 146,000

Check Your Progress

1. What basis of accounting is used for expenditures of a Debt Service Fund? What
exceptions is usually followed in recognizing Expenditures for matured Bonds principal
and interest?

______________________________________________________________________
______________________________________________________________________
2. What Assets and liability accounts would you expect to find in a Balance Sheet statement
of a Debt Service Fund?
______________________________________________________________________
______________________________________________________________________
3. What are the different types of long-term debts that could be accounted for in a
Governmental unit’s DSF.
______________________________________________________________________
______________________________________________________________________
4. What are the accounts to be made when a budget is prepared in a DSF?
______________________________________________________________________
______________________________________________________________________
5. Describe considerations to be made in an appropriations budget of a DSF.
______________________________________________________________________
______________________________________________________________________
6. Describe the sources of financing which could be used to service debts in DSF.
______________________________________________________________________
_____________________________________________________________________
7. Explain how the General Fund is used to account for Debt Service.
______________________________________________________________________
______________________________________________________________________

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8 What does a ledger account of a debt service fund includes different from other
funds?
______________________________________________________________________
______________________________________________________________________
9. Describe Refinancing and how it is used as a source of finance for a DSF.
______________________________________________________________________
______________________________________________________________________

10. Explain one peculiarity of the accrual basis of accounting of governmental fund
types which only applies to DSF.
______________________________________________________________________
______________________________________________________________________

5.10 SUMMARY

In addition to the serial bonds, Term Bond issues mature in their entirety on a given date, in
contrast to Serial Bonds, which mature in instalments. Required revenues of Term Bonds
Debt Service Funds may be determined on an “actuarial basis” or on a less sophisticated
basis designed to produce approximately level contributions during the life of the issue.
Generally legal requirements govern the establishment of DSF. In the absence of legal
requirements or of a formal plan for accumulation of a sinking fund or for repayment of a
General Obligation Term Bond, there is no need to establish a debt service fund.

5.11 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS

1. Refer to the topic 5.2


2. Refer to the topic 5.7 & 5.2
3. Refer to the topic 5.3
4. Refer to the topic 5.5
5. Refer to the topic 5.5
6. Refer to the topic 5.5
7. Refer to the topic 5.6
8. Refer to the topic 5.2

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9. Refer to the topic 5.5
10. Refer to the topic 5.5

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