debt service funds

A major goal of governmental financial reporting is assessing financial performance, that is, how well the government is doing with the money entrusted to it. From the standpoint of making judgments about the performance of government funds and government finance, the financial reports are a good place to start. These reports can provide a considerable amount of the information for gauging financial compliance, success, and health. Governmental and nonprofit accounting both use the concept of fund accounting. In fund accounting, the entity is divided into subsets or “funds” each with its own self-balancing set of accounts. Even though GASB Statement #34 will dramatically change the reporting format, the concept of fund accounting will remain the key difference between governmental and private sector accounting. A look at the various types of funds can lead to a better understanding of the impact they have on accounting disciplines. The funds are grouped into three fund types: governmental, proprietary, and fiduciary. There are also account groups, but account groups are not funds because they do not have transactions in the ordinary course of business. Instead, they are holding places for items such as fixed assets and long-term debt. Our focus is on one example of a governmental fund called a debt service fund.
Codification section 1300.104a(4) defines a debt service as a fund to account for the accumulation of resources for, and the payment of, general long-term principal and interest. Debt service funds are used for the accumulation of monies to make required payments on principal and interest for such liabilities as bonds and capital lease payments. General long-term liabilities are those that arise from activities of Governmental funds and that are not accounted for as fund liabilities of a proprietary or fiduciary fund. General long-term liabilities are reported in the governmental activities column of the government-wide statement of net assets, but are not reported as liabilities of governmental funds. Governmental fund types account for only short-term liabilities to be paid from fund assets. The proceeds of long-term debt issues may be placed in a governmental fund, but the long-term liability must be recorded in the governmental activities at the government-wide level.
The Reporting Long-Term Liabilities principal states that long-term liabilities to be serviced from the revenues of a proprietary fund should be accounted for by the proprietary fund along with service of such debt. However, long-term debt to be serviced by tax levies, or special assessments, should be accounted for at the government-wide level. Revenues raised by taxes or special assessment for the specific purpose of debt service (as well as any expenditures of debt service) should be recorded in a debt service fund, which is the topic of this a presentation.
Types of obligations whose payment of interest and principal may be accounted for by the debt service fund include serial bonds, term bonds, and notes. Serial bonds are obligations whose principal is repaid over a number of years. Interest payments are typically made on a semi-annual basis from the time of issue, while the principal repayments are not made until after the passage of a number of years, but then made at regular intervals. Transfers to the debt service fund should expect the normal interest payments as well as various “serial” principal repayment dates in order to spread the repayment of the obligation ratably over the life of the bond. Term bonds have no principal repayment until the single maturity date of the bond. As with serial bonds, interest payments are usually made currently on a semiannual basis. Use of a debt service fund is particularly important with term bonds to ensure that adequate resources are set-aside during the bond’s term to provide for repayment of principal at the maturity date. The amount of resources to set aside every year to transfer to the debt service fund depends on the present value of the future repayment obligation, which in turn depends on the selection of an appropriate and realistic discount rate. This discount rate should approximate the expected investment return on funds transferred to the debt service fund.
Notes differ from bonds in that their maturity dates are frequently much shorter and the debt agreements are less formal. The requirements placed on the borrower are less burdensome than those for longer-term