Accounting for Bond Issues or Debt Financing

1 Accounting for bond Issues or Accounting for bond Issues or debt FinancingDebt FinancingSpeaker: Speaker: Linda W. Dufresne, Linda W. Dufresne, CPA, CPA, President, Dufresne & Associates, CPA, PAPresident, Dufresne & Associates, CPA, PACourse ObjectivesCourse Objectives Life of a bond issue Proper entries to record your governmental fund and proprietary fund bond transactions Use of Accounting funds Recording bond issuance Recording bond proceeds expenditures Year end adjustments Practice example transaction Disclosures Financial Statements EMMA Build America BondsLife of a bond IssueLife of a bond issue Pre-issuance Inducement resolutions bond documents drafted by bond counsel Trust indenture/ordinance/resolution creates trust estate and establishes legal foundation for tax exemption of interest on the bonds Official statement Offering document disclosing information required to be disseminated to potential purchasers of the bonds Loan agreement Obligation to repay debt created by the bonds Closing documents bond documents reviewed and comments provided to bond counsel by Co- bond counsel Issuer counsel Disclosure counsel Trustee

2 Counsel Financial advisor Issuer finance personnel and governing body Award resolutionLife of a bond IssueLife of a bond issue Pre closing Final corrections made to bond documents All documents executed be sure you leave the table with what you need to record the transaction! Resolutions/ordinances Closing memorandum Arbitrage certificate Closing Bonds delivered Funds disbursed!!Proper entries to record governmental Proper entries to record governmental fund bond issuance transactionsfund bond issuance transactions Identify transaction elements refer to resolutions/ordinances, closing memorandum and/or arbitrage certificate Capital Project Capitalized interest Par value of bonds Original issue discount or premium Underwriter s discount bond insurance costs, if any Costs of issuance Funded debt service reserve Proper entries to record governmental Proper entries to record governmental fund bond issuance transactionsfund bond issuance transactions Potential governmental Accounting funds Capital Projects Fund to expend proceeds debt Service Fund to record capitalized interest and payment of principal and interest.

3 Fund for reserves debt Service Fund may be used to account for payment of issuance costs includes underwriter s discount Separate fund to record long-term liability and capitalize discount/premium & costs Discounts (OID) Proceeds received are less than face value Record Other Financing Uses do not net against Other Financing Sources Premiums (OIP) Proceeds received are greater than face value Record separate Other Financing Sources bond Premium do not add to Other Financing Sources When to use General Fund or Establish When to use General Fund or Establish Other Type of Governmental FundOther Type of Governmental Fund Number of Funds Principle Care should be taken in applying the number of funds principle A government should use the LEAST number of individual funds possible Governmental units should establish and maintain only those funds required by law and sound financial administration Unnecessary funds result in inflexibility.

4 Undue complexity and inefficient financial administration Distinguish Accounting from financial reporting Accounting system must collect all data needed to ensure and demonstrate legal compliance Financial reporting is concerned with only those aspects of compliance that are of importance to users of general purpose external financial reports Not every fund used for internal Accounting purposes should automatically be classified as a fund in general purpose external financial reportsWhen to use General Fund or Establish When to use General Fund or Establish Other Type of Governmental FundOther Type of Governmental Fund Capital Projects Fund Useful to report major capital acquisition and construction separately from ongoing operations Avoids distortions in financial resources trend information GAAP provide for use of capital projects funds to account for financial resources to be used for the acquisition or construction of major capital facilities (other than those financed by proprietary funds and trust funds)

5 Decision to establish a capital projects fund does not mean that ALL capital acquisition and construction MUST be accounted for in that fund Routine purchase of capitalizable items such as police vehicles typically is reported in the general fund Use this fund type when financial resources trend data would be distorted if not reported separately from operationsWhen to use General Fund or Establish When to use General Fund or Establish Other Type of Governmental FundOther Type of Governmental Fund Capital Projects Fund Especially common for major capital acquisition or construction activities financed through borrowings or contributions Focus is on construction and acquisition Should NOT be used as a reserve to accumulate resources for future capital improvements Unless a legal requirement exists to use a capital projects fund, the fund type is permitted rather than required A single capital projects fund may be sufficient for general purpose external financial reporting provided that proper level of detail is maintained in the government s Accounting systemWhen to use General Fund or Establish When to use General Fund or Establish Other Type of Governmental FundOther Type of Governmental Fund debt Service Fund Normally permitted rather than required Two specific instances where required Legally mandated If financial resources are being accumulated for principal and interest payments maturing in future years Generally interpreted to apply ONLY to accumulations of resources in excess of a full year s principal and interest payments Often a debt Service Fund is used to account for issuance costs A single debt service fund may be sufficient for general purpose external financial reporting provided that proper level of detail is

6 Maintained in the government s Accounting systemPostPost--closing closing the REAL fun begins!the REAL fun begins! Record bond issuance entries Governmental fundsIssuance scenario: City with 9/30 fiscal year Issues general government debt at fixed rate on 3/1/2011 with a dated dateof 3/1/2011, first interest and principal payment date 9/1/2011 to build a new City hall as follows: Sources: $10,000,000 face amountUses: $300,000 capitalized interest, $432,000 original issue discount, $200,000 underwriter s discount, $160,000 costs of issuance, $1,000,000 to be deposited to debt service reserve account, $7,908,000 capital projects fund2011 expenditures: $1,500,000 proceeds spent as of 9/30/2011 on construction; $100,000 principal and $210,000 interest paid on bonds on 9/1/20112011 government-wide expenses: $35,000 accrued interest as of 9/30/2011, $12,000 COI amortization; $14,400 OID amortizationProper entries to record Proper entries to record governmental governmental fundfundbond issuance transactionsbond issuance transactionsAll cash aspects of issuance transaction are recorded equal to face value of debtDRCRCash Capital Projects Fund7,908,000 Cash debt Service FundReserve Account1,000,000 Cash debt Service FundCapitalized Interest Account300,000 Other Financing Uses Original issue Discount432,000 Other Financing Uses debt Service Fund - Issuance Costs360,000 Other Financing Sources bond Proceeds 10,000,000 Proper entries to record Proper entries to record governmental fundgovernmental fundbond transactions during the current periodbond transactions during the current periodDRCRR ecord monthly bond proceeds expenditures Expenditures capital outlay city hall3/31/2011100,0004/30/2011200,0005/31 /2011250,0006/30/2011275,0007/31/2011325 ,0008/31/2011200.

7 0009/30/2011150,000 Cash Capital Projects Fund1,500,000 Proper entries to record Proper entries to record governmental fundgovernmental fundbond transactions during the current periodbond transactions during the current periodDRCRR ecord 9/1/2011 debt principal payment Cash 100,000 Other Financing Sources transfers in general fund100,000 Cash with Fiscal Agent100,000 Cash100,000 Expenditures - debt service principal generalgovernment debt100,000 Matured Principal Payable100,000 Matured Principal Payable100,000 Cash with Fiscal Agent100,000 Proper entries to record Proper entries to record governmental fundgovernmental fundbond transactions during the current periodbond transactions during the current periodDRCRR ecord 9/1/2011 debt interest payment Cash is on hand in the debt service fund because bond proceeds were deposited into the debt service fund for capitalized interest in the amount of $300,000.

8 No transfer from the General Fund is necessary to make this interest payment. However, once the capitalized interest on deposit in the debt service fund is exhausted, transfers from the General Fund will be with Fiscal Agent210,000 Cash210,000 Expenditures - debt service interest generalgovernment debt210,000 Matured Interest Payable210,000 Matured Interest Payable210,000 Cash with Fiscal Agent210,000 GovernmentGovernment--wide wide Conversion EntriesConversion Entries Data must be converted from the current financial resources measurement focus and the modified accrual basis of Accounting to the economic resources measurement focus and the accrual basis of Accounting Once all conversion entries have been made, accounts originally described as expenditures will actually represent expenses ; there is no need to establish separate expenses accounts Year End Adjustments to record Year End Adjustments to record governmentgovernment--widewideconversion entriesconversion entries Government-wide (full accrual) Accounting : Record long-term General Obligation debt Capitalize issuance costs Deferred Charges ( issue costs) Capitalize original issue discount DR Discount on Bonds Sold (OID) Capitalize original issue premium CR Premium on Bonds Sold (OIP) Reclassify expenditures for principal payments on debt DR General Obligation debt Reclassify expenditures for acquisition and construction DR Construction in Progress Record government-wide expenses Amortization of discounts/premiums, costs of issuance Accrued interest payableYear End Adjustments to record Year End Adjustments to record governmentgovernment--widewideconversion entriesconversion entriesACTION NEEDED.

9 The issuance of debt needs to be reflected on the government-wide statement of net assets rather than in the government-wide statement of activitiesDRCRR ecord long-term debt Other Financing sources bond proceeds10,000,000 GENERAL OBLIGATION DEBT10,000,000 Capitalize issuance costsDRCRDEFERRED CHARGES ISSUANCE COSTS360,000 Other Financing uses debt Service issuance costs360,000 Capitalize original issue discount(OID) DRCRDEFERRED CHARGES OID432,000 Other Financing Uses Original issue Discount432,000 Year End Adjustments to record Year End Adjustments to record governmentgovernment--widewideconversion entriesconversion entriesACTION NEEDED: Remove debt service principal payments and treat the amount paid as a reduction of the balance of the related CRConvert debt principal payment to liability reductionGENERAL OBLIGATION DEBT100,000 debt service principal generalgovernment debt100,000 Year End Adjustments to record Year End Adjustments to record governmentgovernment--widewideconversion entriesconversion entriesACTION NEEDED: Remove expenditures incurred for the acquisition or construction of capital assets and report instead a capital asset for the items thus acquired on the statement of net CRConvert capital outlay fromcapital projects fund to capital assetsCONSTRUCTION IN PROGRESS1,500,000 Expenditures - Capital Outlay City Hall1,500,000 Year End Adjustments to record Year End Adjustments to record governmentgovernment--widewideconversion entriesconversion entriesACTION NEEDED.

10 Discounts and deferred charges need to be amortized in the government-wide statement of activities. Assume a 30 year bond , straight line amortization, full amortization in year of issuance if bonds are outstanding > 6 months, no amortization in year of issuance if < 6 amortization of issuance costsExpenditures general government12,000 DEFERRED CHARGES ISSUANCE COSTS12,000 Record amortization of original issue discount(OID)DRCRDebt Service Interest14,400 DEFERRED CHARGES OID14,400 ACTION NEEDED: Expenses need to be accrued in connection with liabilities incurred during the period, but not normally expected to be liquidated with current available financial accrued interest payableDRCRDebt Service - Interest 35,000 Matured Interest payable35,000 Early Recognition of debt Service Expenditures Early Recognition of debt Service Expenditures in in governmental debt service fundsgovernmental debt service funds Exception to general rule that governmental funds should NOT report expenditures and liabilities in connection with unmatured long-term debt Option exists to recognize an expenditure and a liability in a debt service fund in the current period if: debt service fund resources have been provided during the current year.