Chapter 8

Long-term Obligations

/(CHAPTER 8)

1. Unlike individuals and businesses, governments cannot seek protection under the Federal Bankruptcy Code.

2. General obligation debt is the obligation of the government at large and is thereby backed by the government’s “full faith and credit” and revenue-raising powers.

3. Revenue debt is secured only by designated revenue streams.

4. When the proceeds of general long-term debt are received by a governmental fund, the debit to cash is offset by another financing source on the fund statement.

5. Per GASB, governments should report resources and actual short-term obligations.

6. A government is prohibited from ever recognizing bond anticipation notes (BANs) as long-term obligations.

7. Tax anticipation notes (TANs) must be reported as current liabilities of the governmental funds in which the related revenues will be reported, as well as in the government-wide statements.

8. Governments may enter into operating leases, but may not enter into capital leases.

9. In accounting for operating leases, the rental payments should be recognized as expenditures in a governmental fund and as expenses in the government-wide statement of activities in the periods in which they apply.

10. Because they are not obligations of the government at large, revenue bonds are usually not subject to voter approvals or other forms of voter oversight.

11. Although governments may elect to report conduit debt in their government-wide and proprietary fund statements, the GASB has ruled that note disclosure is sufficient.

12. Financial analysts look at the ratio of assessed value of property to total market value of property as a measure of a government’s ability to issue new revenue bonds.

13. Overlapping debt refers to the obligations of property owners within a government’s boundaries for their proportionate share of the debt of other governments with overlapping geographic boundaries.

14. A government’s debt margin is the difference between its authorized debt limit and its outstanding debt.

15. A high bond rating by a recognized agency guarantees the creditworthiness of a government’s debt.

16. The asset and the liability associated with subscription-based information technology arrangements (SBITAs) are amortized over the term of the agreement.

ANSWERS TO /(CHAPTER 8)

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MULTIPLE CHOICE (CHAPTER 8)

1. A government that is unable to satisfy claims against it
2. Is prohibited from filing bankruptcy.
3. May seek protection under the Federal Bankruptcy Code, using the same section that is used by businesses.
4. May seek protection under the Federal Bankruptcy Code, using a special section directed to governments.
5. Is automatically placed under the jurisdiction of a higher level of government.
6. To seek protection under the Federal Bankruptcy Code, a government must
7. Be unable to provide the level of services it has provided in the recent past.
8. Be unable to pay its debts in the current year.
9. Have budgeted expenditures in excess of revenues.
10. Both (b) and (c).
11. When the proceeds of long term debt are reported in governmental fund financial statements
12. They are reported only as an increase in liabilities in the funds.
13. They are reported only as revenues in the funds.
14. They are reported only as an other financing source—debt proceeds.
15. They are reported only as an other financing use—debt proceeds.
16. In governmental fund financial statements, the assets acquired under a capital lease would be reported at

a) The total of all payments required under the lease.

b) The present value of the required lease payments.

c) The undiscounted total of required lease payments.

d) They are not reported in the fund financial statements.

1. In the government-wide financial statements, the assets acquired under a capital lease would be reported at

a) The total of all payments required under the lease.

b) The present value of the required lease payments.

c) The undiscounted total of required lease payments.

d) They are not reported in the government-wide financial statements.

1. Safou County issued $25 million of 5 percent demand bonds for construction of a county maintenance building. The county has no take-out agreement related to the bonds. It estimates that 20 percent of the bonds would be demanded (called) by the buyers if interest rates increased by at least one percentage point. At year-end, rates on comparable debt were 7 percent. How should these demand bonds be reported in the government-wide financial statements at year-end?
2. $25 million in the long-term liabilities section of the governmental activities column.
3. $5 million in the current liabilities section of the governmental activities column AND $20 million in the long-term liabilities section of the governmental activities column.
4. $5 million in the governmental activities column AND $20 million would be reported in the schedule of changes in long-term obligations.
5. $25 million in the current liabilities section of the governmental activities column.
6. Sorrel County issued $25 million of 5 percent demand bonds for construction of a county maintenance building. Before year-end the county entered into a two-year noncancellable take-out agreement with a local bank with a 10-year payback period. The county estimates that 20 percent of the bonds would be demanded (called) by the buyers if interest rates increased by at least One percentage point. At year-end, rates on comparable debt were 7 percent. How should these demand bonds be reported in the county’s government-wide financial statements at year-end?
7. $25 million in the long-term liabilities section of the governmental activities column.
8. $5 million in the current liabilities section of the governmental activities column AND $20 million in the long-term liabilities section of the governmental activities column.
9. $5 million in the governmental activities column AND $20 million would be reported in the schedule of changes in long-term obligations.
10. $25 million in the current liabilities section of the governmental activities column.
11. Spindle County issued $25 million of 5 percent demand bonds for construction of a county maintenance building. The county has no take-out agreement related to the debt. It estimates that 20 percent of the bonds would be demanded (called) by the buyers if interest rates increased by at least one percentage point. At year-end, rates on comparable debt were 7 percent. How should these demand bonds be reported in the governmental fund financial statements at year-end?
12. $25 million in the capital projects fund.
13. $5 million in the capital projects fund AND $20 million would be reported in the schedule of changes in long-term obligations.
14. $20 million in the capital projects fund AND $5 million would be reported in the schedule of changes in long-term obligations.
15. $25 million in the schedule of changes in long-term obligations.
16. Voters of Vadouvan School District, a public school district, approved construction of a new high school at a cost not to exceed $20 million. The district will finance the construction by issuing $20 million of 6 percent term bonds payable in 20 years. Because the site had already been prepared, the school district began construction immediately but the bonds would not be issued for nearly a year. Shortly before the fiscal year-end, the school district borrowed $5 million from a local bank due in one year with interest at 6.2 percent. The note will be repaid from bond proceeds. The school district secured a financing agreement with the bank to convert the debt to a 10-year debt if the school district is unable to sell the bonds by the due date. At year-end, how should the $5 million note be displayed in the governmental fund financial statements?
17. Capital projects fund—Notes payable $5 million; Nothing in the schedule of changes in long-term obligations.
18. Capital projects fund—Notes payable $5 million; $15 million in the schedule of changes in long-term obligations.
19. Capital projects fund—Encumbrances of $5 million; $15 million in the schedule of changes in long-term obligations.
20. Nothing in the capital projects fund AND $5 million notes payable in the schedule of Changes in long-term obligations.
21. Dogwood County has a December 31 fiscal year-end. In November, the county borrowed $8 million from a local bank, due in six months at 6 percent interest, to finance general government operations. The county pledges property tax revenues to secure the loan. At year-end, how should the county display the bank note in the governmental fund financial statements?
22. Nothing in the General Fund; Nothing in the schedule of changes in long-term obligations.
23. General fund--$8 million in other financing sources; Nothing in the schedule of changes in long-term obligations.
24. General fund--$8 million in other financing sources; $8 million in the schedule of changes in long-term obligations.
25. General fund--$8 million in notes payable; Nothing in the schedule of changes in long-term obligations.
26. GASB Statement No 87 requires specifies which of the following
27. Leases one year or more in length must be accounted for as a financing lease
28. The lessee account for the lease as if it had purchased the rights to the asset and borrowed the purchase price.
29. The treatment of leases of buildings, land and equipment, but excludes the treatment of intangible assets
30. All of the above.
31. Oxalis City entered into a capital lease agreement as a lessee for several new dump trucks to be used in general government activities. The city maintains its books and records in a manner that facilitates the preparation of the fund financial statements. Which of the following is ?
32. The title of the asset is transferred to Olden City.
33. The lease is recorded as a long-term liability at the present value of the lease.
34. The interest expenditure would be recorded on the government-wide financial statements.
35. The term of the lease is specified in the lease contract without consideration of cancellation options.
36. When the government acts as a lessor, which of the following reflects entries on the government-wide statements at the time the lease is signed?
37. The lessor is selling the rights to the entire economic life of the asset.
38. The lessor is selling a portion of the life economic life of the asset.
39. The lessor should recognize a gain on the lease if the expected payments exceed the value of the asset
40. The lessor should immediately write off the fair value of the asset leased
41. The lessor should offset the receivable with the depreciation of the asset.
42. The lessor should offset the receivable with deferred inflow of resources
43. Nolana City enters into a lease agreement that contains a nonappropriation clause. The clause
44. Has been held by courts in 26 states to effectively cancel the lease.
45. Stipulates that the yearly lease payment must be appropriated by the city council each year.
46. Prohibits the city from replacing leased property with similar property.
47. Permits the city to lease at lower rates than would be possible without the presence of the clause.
48. Why would a government issue revenue bonds (which generally are issued at a higher rate of interest than general obligation bonds) even though the government knows that if revenues from the project are not sufficient to cover principal and interest payments, the government will use resources from general government activities to fund the principal and interest payments?
49. Revenue bonds may not require approval of the voters.
50. Revenue bonds may not be considered in legal debt limitations.
51. Revenue bonds may permit the interest costs to be passed on to the users of the services financed.
52. All of the above.
53. Which of the following funds is most likely to receive the proceeds of revenue bonds?
54. General fund.
55. Capital projects fund.
56. City utility enterprise fund.
57. Highway department special revenue fund.
58. Obligations of property owners within a particular government for their proportionate share of debts of other governments with whom their government shares boundaries are called
59. Overlapping debt.
60. Conduit debt.
61. Committed debt.
62. Moral obligation debt.
63. Overlapping debt should be reported in which of the following ways?
64. It should be reported in the schedule of changes in long-term obligations.
65. It should be disclosed as a note to the financial statements.
66. It should be reported in a schedule in the statistical section of the annual report.
67. It should not be reported anywhere in the annual report.
68. Obligations issued in the name of a government on behalf of a nongovernmental entity are called
69. Overlapping debt.
70. Conduit debt.
71. Committed debt.
72. Moral obligation debt.
73. Periwinkle City issued $20 million of bonds at par. The city loaned the proceeds to Sharpe Cheese Processors to expand the size of its facility, which would allow Sharpe to hire additional workers. The loan payments from Sharpe to the city are established to match the principal and interest payments on the bond issue. The bonds are payable exclusively from the loan repayments by Sharpe. The bonds are secured by the additional plant facilities built by Sharpe. Where should the city report the bonds in its annual financial report?
74. In the government-wide financial statements.
75. In the notes to the financial statements.
76. In the proprietary fund financial statements.
77. In any of the above ways.
78. Industrial development bonds are issued in the name of a government with the proceeds used to attract private businesses to a community. Which of the following is a statement about industrial development bonds?
79. The proceeds are used by the private corporations and principal and interest payments are made by the private corporation. The government backs the bonds in the event of default by the private corporation.
80. The proceeds are used by the private corporations and principal and interest payments are made by the private corporation. The government does not back the bonds in the event of default by the private corporation.
81. The proceeds are used by the government to build infrastructure to service private corporations, with principal and interest payments made by the government out of the additional tax revenues received from the private corporation.
82. The proceeds are used by the government to build infrastructure to service private corporations, with principal and interest payments made by the private corporation in lieu of property taxes.
83. Evolvus City has $47 million of debt recorded in its schedule of changes in long-term obligations, made up of $30 million of general obligation debt, $1 million of compensated absences payable, $4 million of claims and judgments, and $12 million of obligations under capital leases. The state limits the amount of general obligation debt that can be issued by a city to 20 percent of the assessed value of its taxable property. The assessed value of property in Easterly City is $250 million. The city’s legal debt margin is
84. $ 3 million.
85. $ 20 million.
86. $ 30 million.
87. $50 million.
88. Alexandrite State created a housing authority to provide financing for low-income housing. The authority issues bonds and uses the proceeds for that purpose. Currently the authority has outstanding $200 million in bonds backed by the state’s promise to cover debt service shortages should they arise. The state constitution specifically limits the state to no more than $2 million in general obligation debt. How can the state officials defend the $200 million in debt outstanding?
89. The debt is not general obligation debt.
90. The state is only morally obligated for the debt.
91. The debt is the debt of the authority, not the state.
92. All of the above.
93. Debt that is issued by one entity but backed by the promise of another entity to make up any debt service deficiency is
94. Committed debt.
95. Overlapping debt.
96. Conduit debt.
97. Moral obligation debt.
98. Brassica City entered into a long-term capital lease for some office equipment. The city maintains its books and records in a manner to facilitate preparation of fund financial statements. What entry should be made in its general fund to record this event?
99. Debit Expenditures; Credit Other financing sources—leases.
100. Debit Equipment; Credit Other financing sources—leases.
101. Debit Equipment; Credit Leases payable.
102. No entry, because this event had no effect on financial resources.
103. Gardenia City’s electric utility enterprise fund made its annual interest payment on its outstanding $20 million of 6 percent bonds, which were originally issued at a premium. The city maintains its books and records in a manner that facilitates preparation of fund financial statements. The entry to record the interest payment would include a credit to cash for the amount of the interest checks written and debit(s) to
104. Interest expenditure AND bond premium.
105. Interest expense AND bond premium.
106. Interest expenditure only.
107. Interest expense only.
108. Which of the following is likely to be used by a bond rating agency to rate a government’s general obligation bonds?
109. A review of the basic financial statements.
110. Consideration of economic statistics such as unemployment rates.
111. Consideration of legal debt margin.
112. All of the above.
113. In a bond covenant, a city agreed to create and maintain a $2 million reserve. These funds can be used
114. Only to make the final year’s interest and principal payments on the bonds.
115. Only to make the interest and principal payments on the bonds in a year in which the city is unable to make them from other resources.
116. To make either the final year’s interest and principal payments on the bonds or to make the payments in any year that the city is unable to make them from other resources.
117. By the city as it chooses since the funds legally belong to the city.
118. Bond insurance issued by credit enhancement agencies
119. Assures the holder of the debt that all interest and principal payments will be made.
120. Ensures that the bonds receive the highest possible rating.
121. May seem cost prohibitive to many governments.
122. All of the above.
123. The work of bond rating agencies is important because
124. They ensure that all principal and interest payments on bonds issued will be made.
125. The rating they assign proves the quality of a particular debt instrument.
126. They affect the debt’s marketability and hence its interest rate.
127. Bonds cannot be issued without them.

31. Foxglove City is accumulating financial resources that are legally restricted to payments of general long-term debt principal and interest maturing in future years. At year-end, $7,000,000 has been accumulated for principal payments, and $2,200,000 has been accumulated for interest payments. These restricted funds should be accounted for in the

General Fund Debt Service Fund

1. $0 $9,200,000
2. $9,200,000 $0
3. $2,200,000 $7,000,000
4. $7,000,000 $0

32. Which of the following is not likely to be a reason why a government might obtain an asset through an operating lease? The government

a) Does not have enough cash or credit to purchase the asset.

b) Wishes to avoid the risk of owning an asset that has become obsolete and cannot be sold.

c) Believes the total value of assets reported in the schedule of changes in capital assets is already too high.

d) Needs the asset for only a small part of its useful life.

33. Which of the following is about FASB leasing standards?

a) FASB standards are identical to GASB standards.

b) FASB has three type of leases for lessees: sales type, direct financing and operating.

c) FASB distinguishes between capital and operating leases.

d) Governments have the option to follow the FASB standards.

1. Plumbago City contracted with Big City Software to use securities trading software. At the beginning of the contract period which of the following is the basis for determining the liability recognized by Plumbago City?
2. Market value, the advertised price of a one-year contract for the software
3. Sum of scheduled payments
4. Present value of sum of scheduled payments
5. No liability is recognized
6. In 2015, Plumeria City issued 10 year bonds on behalf of Dragonfly, a not-for-profit organization aimed at improving health in the city. In 2022, Dragonfly files for bankruptcy as a result of a large, unexpected, increase in staffing costs due to the COVID-19 pandemic. At what point will Plumeria City recognize a liability for the debt held by Dragonfly that was part of the conduit debt arrangement.
7. When Plumeria City has legally assumed the debt of Dragonfly, most likely after the bankruptcy proceeding have been completed
8. When it is more likely than not that Plumeria City will have to pay the debt of Dragonfly.
9. The liability was already recognized in the financial statements of the City at the time the debt was issued in 2015.
10. Plumeria City will not ever recognize Dragonfly’s debt. By definition, conduit debt never becomes the liability of the governmental entity that issued the debt.
11. Peony City contracts with Big City Software to use a securities trading software. Which of the following is not included in the capitalization of the asset at the beginning of the subscription period?
12. Costs Peony city incurred for city employees to participate in community college courses to understand how to use the software
13. Present value of the sum of scheduled payments
14. Payments made to Big City Software as deposits during the contracting period to secure the right to use of the technology
15. Installation costs of hardware required to use the software

PROBLEMS (CHAPTER 8)

1. During the fiscal year ended 6/30/24, Hebe City engaged in the following transactions.

REQUIRED: Assume that the city maintains its books and records in a manner that facilitates the preparation of its governmental fund financial statements. Prepare all necessary journal entries that the city should make for each transaction. Clearly indicate in which fund the entry is being made. If no entry is required, write “No entry required.”

1. In July 2023, the city issued $30 million in 6% general obligation term bonds to finance construction of a new building to house city offices. The bonds were issued at a premium of $300,000.
2. In September 2023, the city transferred $1.5 million from the general fund to cover the $0.9 million principal and $0.6 million interest payments due that month on debt issued in previous years.
3. In September 2023, the city paid the principal and interest due from (b).
4. In June 2024, the city transferred $3 million from the general fund to cover the $1.8 million interest payment and the $1.2 million principal payment due in July 2024 on the bonds issued in (a).
5. Roundleaf City entered into the following transactions during the current year. REQUIRED: Assume that the city maintains its books and records in a manner that facilitates the preparation of its fund financial statements. Prepare entries to record the following transactions. Indicate the fund in which the entry is being made.

a) The city issues $5 million of tax anticipation notes, backed by property taxes that will be recorded in the general fund.

b) The city issues $2 million of 90-day bond anticipation notes that it expects to roll over into long-term bonds.

c) The city repays the $5 million in (a) plus $0.125 million in interest.

d) The city successfully issues $20 million in long-term bonds and repays the notes in (b).

1. Yucca County engaged in the following debt-related transactions during the year.

REQUIRED: Assume that the county maintains its books and records in a manner that facilitates the preparation of its government-wide financial statements. Prepare the necessary journal entries to record these transactions. Clearly indicate if debt is long-term or short-term (current). If no entry is required, write “No entry required.”

1. The county issued $10 million in 6 percent, 20-year bonds for $10,234,932 to yield 5.8 percent (2.9 percent per semi-annual period) to the investor.
2. The county made the first semi-annual interest payment on the bonds in (a).
3. The county issued $3 million in 6 percent demand bonds for which it did not enter into a take-out agreement.
4. In anticipation of finally issuing $20 million in bonds that were approved by the voters several months ago, the county borrowed $20 million from a consortium of national banks due in six months. The county also entered into a financing agreement with the consortium to convert the debt to 10-year debt if long-term bonds were not sold successfully.
5. In anticipation of property tax revenues to be received several months after its fiscal year-end, the county borrowed $2 million from a local bank payable in nine months.
6. The county leased a new machine for its county highway department in an arrangement that qualified as a capital lease. The present value of the minimum lease payments is $250,000, which approximates the fair value of the machine.
7. Mayflower City is located in Hazel County. Mayflower Valley School District encompasses all of Mayflower City and some of Hazel County. Property in Mayflower City is assessed at $400 million; property in Hazel County is assessed at $800 million; property in Mayflower Valley School District is assessed at $600 million. The total debt outstanding for Mayflower City is $30 million; Hazel County is $50 million; Mayflower Valley School District is $45 million.

REQUIRED: For Mayflower City, compute (a) the amount of direct debt and (b) the amount of overlapping debt.

5. In August 2023, the voters of Chrysanthemum City approved construction of a new public library at the cost of $20 million, to be financed by general obligation bonds. The city put the contracts out to bid and approved the bid of the lowest bidder. In September 2023, the city began the long process of issuing the general obligation bonds. However, so that construction could begin immediately, the city also issued $5 million in bond anticipation notes in September 2023, maturing in March 2024. In December 2023, one of the city’s major manufacturers announced that it would be closing its plant in the city, eliminating over half of the jobs currently available in the city.

REQUIRED:

(a) Prepare journal entries to initially record the issuance of the BANs in the city’s capital projects fund as well as in its government-wide financial statements.

(b) The city decided to reconsider the scope of the library project in light of the plant closure, prepare any entries necessary to change the reporting of the BANs assuming that the city negotiated a 6-month extension of the initial due date for the BANs and would not issue any general obligation bonds before issuing its June 30, 2024 financial statements.

6. Marguerite City engaged in two types of debt transactions in its fiscal year ending December 31, 2023. The city issued its financial statements for 2023 on May 15, 2024.

• 1. In November 2023, the city issued $4 million in bond anticipation notes (BANs) to finance construction of a new maintenance facility. The proceeds were placed in a capital projects fund and the city began construction immediately. Although the city intended to refinance the BANs with long-term bonds, interest rates were higher than anticipated and as of May 15, 2024 the city had neither issued the bonds nor entered into an agreement to do so. How, if at all, should the debt be reported in the capital projects fund and the government-wide statements? Be specific.
     1. Capital projects fund
     2. Government-wide statements
  2. In October 2023, the city issued $1 million of industrial development bonds to finance the construction of a new fast-food restaurant. The city will construct the facility and lease it to a restaurant chain. The lease satisfies the criteria for a capital lease. The lease payments will be exactly equal to the debt service on the bonds. The bonds are payable exclusively from the lease payments. In the event the restaurant chain defaults on its lease payments, the bondholders have a claim only against the restaurant chain and the leased property, not against the city. In its December 31, 2023 government-wide statement of net position, the city did not report the debt as a liability. Assuming that the amount involved is material, would you as an auditor issue an unqualified opinion on the financial statements? Explain and justify your response.

1. Cottonwood County leases an office building with a remaining economic life of 20 years. The fair market value of the building is $6 million. Annual lease payments are agreed at $523,107, based on a 6 percent interest rate. The lease meets the conditions for a capital lease.

1. Record the lease and the first year’s interest payment

(a) In a governmental fund

(b) In the government-wide statements

2. Should the office building be depreciated? If so, how and where should depreciation be recorded?

ANSWERS TO PROBLEMS (CHAPTER 8)

Problem 1

1. CAPITAL PROJECTS FUND

Cash $30.3 million

Other financing sources—bond proceeds $30 million

Other financing sources—premium 0.3 million

[$20 million should be shown as an addition in the schedule of changes in long-term obligations.]

1. GENERAL FUND

Other financing uses—nonreciprocal

transfer-out to debt service fund $1.5 million

Cash $1.5 million

DEBT SERVICE FUND

Cash $1.5 million

Other financing sources—nonreciprocal

transfer-in from general fund $1.5 million

c) DEBT SERVICE FUND

Expenditures $1.5 million

Cash $1.5 million

[$0.9 million should be shown as a retirement in the schedule of changes in long-term obligations.]

d) GENERAL FUND

Other financing uses—nonreciprocal

transfer-out to debt service fund $3 million

Cash $3 million

DEBT SERVICE FUND

Cash $3 million

Other financing sources—nonreciprocal

transfer-in from general fund $3 million

DEBT SERVICE FUND (optional entry)

Expenditure—principal $1.2 million

Expenditure—interest 1.8 million

Matured principal payable $1.2 million

Matured interest payable 1.8 million

[If this optional entry is made, $1.2 million should be shown as a retirement in the schedule of changes in long-term obligations.]

Problem 2

a) GENERAL FUND

Cash $5 million

Tax anticipation notes payable $5 million

b) CAPITAL PROJECTS FUND

Cash $2 million

Other financing sources—proceeds of BANs $5 million

[$2 million should be shown as an addition in the schedule of changes in long-term obligations]

c) GENERAL FUND

Tax anticipation notes payable $5 million

Debt service expenditure—interest 0.125 million

Cash $5.125 million

d) CAPITAL PROJECTS FUND

Cash $20 million

Other financing sources—bond proceeds $20 million

[$20 million should be shown as an addition in the schedule of changes in long-term obligations]

Other financing uses—repay BANs $2 million

Cash $2 million

[$2 million should be shown as a retirement in the schedule of changes in long-term obligations]

Problem 3

a)

Cash $ 10,234,932

Premium $ 234,932

Long-term bonds payable 10,000,000

b)

Interest expense $ 296,813

Premium on bonds payable 3,187

Cash $ 300,000

c)

Cash $ 3 million

Short-term notes payable $ 3 million

d)

Cash $20 million

Long-term BANs $20 million

e)

Cash $ 2 million

Short-term TANs $ 2 million

f)

Equipment held under lease $ 250,000

Lease liability $ 250,000

Problem 4

a. Direct debt is $30 million.

1. Overlapping debt is $55 million, consisting of:

Hazel County debt $50 million x ($400 million/$800 million) = $25 million

Mayflower Valley School District debt $45 million x ($400 million/$600 million) = $30 million.

Problem 5

a. CAPITAL PROJECTS FUND

Cash $5 million

Other financing sources—BAN proceeds $5 million

GOVERNMENT-WIDE FINANCIAL STATEMENTS

Cash $5 million

Long-term liabilities—BANs $5 million

b. CAPITAL PROJECTS FUND

Other financing sources—BAN proceeds $5 million

BANs payable $5 million

[No entry would be needed to extend the due date of the original BANs by 6 months.]

GOVERNMENT-WIDE FINANCIAL STATEMENTS

Long-term liabilities—BANs $5 million

Short-term liabilities—BANs $5 million

Problem 6

A. 1. Capital projects fund

The debt would be reported as a fund liability.

2. Government-wide statements

The debt would be reported as a current (short-term) liability.

B. Yes. The industrial development bonds are conduit debt. They should be

reported in the notes to the financial statements, not in the statement of net

position.

Problem 7

1.

a. Governmental fund

Expenditures— long-lived lease $6,000,000

Other financing sources—capital lease $6,000,000

To record the right to use equipment under lease

Debt service expenditures (lease principal) $ 163,107

Debt service expenditures (lease interest) 360,000

Cash $ 523,107

To record first lease payment

b. Government-wide statements

Building held under capital lease $6,000,000

Lease liability $6,000,000

To record the right to use equipment under lease

Lease liability (lease principal) $163,107

Interest expense (lease interest) 360,000

Cash $ 523,107

To record first lease payment

2. The office building should be depreciated in the government-wide statements. Assuming straight-line depreciation, the city should record annual depreciation expense of $300,000 ($6,000,000/20 years). Depreciation expense would be reported in the government-wide statement of activities. Accumulated depreciation would be reported in the government-wide statement of net position as a reduction of capital assets.

ESSAYS (CHAPTER 8)

1. Identify and define “conduit debt.” What are the current reporting standards for conduit debt issued by governments? Do you agree or disagree with the use of conduit debt by governments? Justify your answer. Do you agree or disagree with the current reporting standards related to conduit debt? Why?
2. Generally accepted accounting principles require governments to report many assets to be reported at market value. However, few liabilities are reported at market value. Present arguments for and against reporting liabilities at market value.

3. Why is information about long-term debt important to financial statement users?

4. What is the distinction between general obligation debt and revenue bond debt? Why might a government issue revenue bond debt instead of general obligation debt?

1. Trollius City is considering issuing $50 million in debt to finance construction of a new sewer system. REQUIRED: Compare the possible financial effects of the city’s decision to finance the new system with

(a) General obligation debt

(b) State-issued sewer revolving bond fund debt, which carries the moral obligation of the state in addition to being a primary obligation of the city through its loan payments to the state

(c) The city’s own sewer revenue bonds, or

(d) General obligation debt insured by a company specializing in municipal bond insurance.

6. What is “overlapping debt” and why is it important to financial analysts and others who use government financial statements?

7. Freesia City financed the construction of sidewalks in a newly annexed subdivision by issuing $50 million in special assessment debt. The debt is to be serviced entirely by assessments against the subdivision’s property owners. The government does not have any obligation for the debt and has not guaranteed it. Nevertheless, when the property owners in a nearby subdivision were unable to pay their required assessments, the city, fearful of damaging its own credit rating, serviced the debt using its own resources. Should the city report the $50 million in special assessment debt in its government-wide statement of net position? Explain, citing specific GASB provisions.

1. On December 31, 2023, Matthiola City issued $50 million of 8 percent, 20-year, demand bonds that give bondholders the opportunity to "put" (i.e. sell) the securities back to the issuer at face value, beginning on January 1, 2024. On December 31, 2023, prevailing interest rates on comparable bonds were 6.7 percent. Should the city report the bonds as a liability on its December 31, 2023 governmental fund financial statements? Explain, indicating any additional information you would need to make a determination.
2. In November 2023, the Feverfew City issued $3 million in 6 percent TANs, payable in April 2024. In what fund or fund type should the city report the TANs on its December 31, 2023 financial statements? Explain, indicating any additional information you would need.
3. Conduit debt refers to obligations issued in the name of a government on behalf of a nongovernment entity, such as a business or not-for-profit organization.

• A general description of the conduit debt transactions.
• The aggregate amount of all conduit debt obligations outstanding.
• A clear indication that the issuer has no obligation for the debt beyond the resources provided by related leases or loans.

1. Overall, if governments have long-term debt outstanding and also hold long-term bonds as an investment, it may appear inconsistent and misleading to show valuation changes on one side of the balance sheet while ignoring valuation changes on the other side.

3. Information on long-term debt is especially important to financial statement users because a government’s failure to make timely payments of interest and principal can have profound repercussions, both for the government’s creditors and for the government itself. Creditors will obviously incur losses. Governments that fail to meet their debt obligations will have difficulty issuing new debt in the future. Inability to issue debt can significantly affect a government’s ability to provide infrastructure and other capital assets. Many of a government’s programs require the use of long-lived assets. For purposes of establishing interperiod equity, most governments finance long-lived capital assets over the life of those assets. Inability to issue new debt can hinder a government’s ability to provide expected services. Because many governments have only a limited amount of legal borrowing power, taxpayers and bondholders also should be interested in the government’s legal debt margin--that is, the difference between its legal debt limit and its outstanding debt.

4. General obligation debt is an obligation of the government at large and is thereby backed by the government’s full faith and credit. Revenue debt, by contrast, is secured only by designated revenue streams, such as from the sale of electricity, highway tolls, rents, receipts from student loans, or patient billings.

• Revenue bonds are usually not subject to voter approval or other forms of voter oversight.
• Revenue bonds may not be considered in legal debt limitations.
• Revenue bonds help governments readily incorporate the cost of debt service (interest) into user fees. This is particularly helpful when many of the users are outside the government’s jurisdiction--for example, revenue bonds issued to finance a toll road.

5.

1. The city’s general obligation debt would carry the full faith and credit of the city and, therefore, would likely carry a lower interest rate (financing cost) than the options contemplated in (b) and (c). However, general obligation debt would likely be considered in the calculation of the city’s legal debt margin.
2. The state revolving fund debt is priced according to the state’s credit quality. In addition, it would not likely be considered in the calculation of the city’s legal debt margin. However, depending on how well the city manages its finances, this credit enhancement might not be as good at the city’s own credit rating in (a).
3. City revenue bonds have the advantage of directly charging the users of the sewer system for the cost of the loan. If the users of the new sewer system are all city residents, however, this advantage would be overshadowed by the higher interest rates that revenue bonds usually carry. In contrast, if many of the new users of the new system will be outside the city’s jurisdiction, this would be an advantage. Revenue bonds are not usually considered in the calculation of the city’s legal debt margin.
4. Bonds that are insured carry the highest rating, and therefore, the lowest possible interest rate for the city. However, the city would need to compare the cost of the insurance, to the interest savings that would result.
5. Overlapping debt refers to the obligations of stakeholders within a particular government for their proportionate share of debts of other governments with overlapping geographic boundaries. It represents additional obligations that are supported from the same sources as the government’s direct debt. Overlapping debt is significant because, like direct debt, it bears upon the government’s fiscal capacity to meet its obligations as they come due.
6. Yes. The government should report the special assessment debt in its government-wide statement of net position. Under GASB standards, as long as the city is “obligated in some manner” for the special assessment debt it must account for the debt as its own. The city is “obligated in some manner” unless it is legally prohibited from assuming the debt and makes no statement or gives no indication that it will or may honor the debt. By assuming the special assessment debt of a similar subdivision, the city clearly indicated that it may honor the debt in the event of default.

8. The city need not report the “put” bonds as a governmental fund obligation as long as it has a “take out agreement” that meets certain requirements. The agreement must not expire for at least a year and must not be cancelable by the lender or prospective lender within that year, and the lender or prospective lender must have the financial wherewithal to honor the agreement. If the demand bonds do not satisfy these criteria, they should be reported as liabilities of the governmental fund receiving the proceeds.

9. Tax anticipation notes (TANs) are always considered short-term liabilities. Hence, they should be reported in the city’s general fund or other governmental fund that will receive the proceeds.