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Baker Tilly Virchow Krause, LLP, is an independently owned and managed member of Baker Tilly International. © 2010 Baker Tilly Virchow Krause, LLP Debt – 2016 Winter Conference 1
Baker Tilly Virchow Krause, LLP, is an independently owned and managed
member of Baker Tilly International. © 2010 Baker Tilly Virchow Krause, LLP
Debt – 2016 Winter Conference
1
Overview
> What is debt?
> Types of debt
> When to issue debt
> Accounting for a debt issuance – modified vs full accrual
> Refunding
> Annual debt service – modified & full accrual
> Disclosure requirements
2
What is Debt?
> Major source of financing
> Often support specific projects & initiatives
- Major construction
- Low fund balance avoidance, advances
- Economic development
> Make payments from:
- Levies, user charges, increment, other
> Limitations
- Statutory limits (5% equalized value)
- Policy constraints
- Cultural or philosophical constraints
3
Types of Debt
> General obligations
- Most common
- Supported by property taxes
- Includes:
• Bonds
• Notes
• State trust fund loans
• Bank Loans (perhaps)
> Revenue obligations
- Guaranteed by specific revenues (user charges) other
than property taxes
- Example: Future water revenues pledged to support debt
issued for water system improvement project
4
Types of Debt (cont.)
> Special assessment bonds
- Issued to support projects benefiting a specific subset of residents
- Guaranteed by future tax assessments on those residents
> Environmental improvement fund loans
- Funded by EPA grants and state match
- Clean water fund program
- Safe drinking water loan program
5
Types of Debt (cont.)
> Installment contracts
- “Payment plan” for purchase of an asset
> Capital leases
> Conduit debt
- Limited-obligation debt to help finance capital acquisition
or construction by a third party outside the government
- Benefiting third party assumes sole responsibility for
repayment of debt
- Government serves as “conduit” between debt holders
and third party
- Not recorded by the government, just a footnote
disclosure
6
Types of Debt (cont.)
7
Statutory Provisions for Debt in Wisconsin
> Ability to issue debt governed by powers derived
from WI statutes
- Chapter 67 – General Obligations
- Section 66.0621 - Revenue Obligations
- Chapter 24 – State Trust Fund Loans
- Sections 66.0701 – 66.0733 – Special Assessment Bonds
- Sections 66.1333 & Sections 66.1335 – HRA, RDA, and
CDA obligations
When to Issue Debt
> Philosophical/Cultural considerations
> User “equity” in matching useful life of
asset/improvement with who pays
- If saving – the savers may not get to use the asset
- If borrowing – payers use the asset over its useful life
> Borrowing at lower, predictable rate may allow for
better management of the tax rates and fees.
> Levy limits have to be part of the consideration
> Recommendation: Formalize in a debt policy
8
When to Issue Debt (cont.)
9
> GFOA Debt Policy Recommendations:
- Written and comprehensive
- Reflects local, state, federal laws and regulations
- Reviewed periodically
- Articulates policy goals
- Provides guidelines for the structure of debt issuance
- Demonstrates a commitment to long-term capital and financial planning
- Sends strong and clear signal to rating agencies and capital markets
- Approved by the governing body
When to Issue Debt (cont.)
10
Debt limitsDebt
structuring practices
Debt issuance practices
Debt management
practices
Trivia
Question:
Which country holds the record for the largest government bond
sale in an emerging market?
Hint:
Just occurred, October 2016
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Answer
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Answer:
Saudi Arabia
• $17.5B
• Attracted 67B in order
• Yields from 2.58 (5 year) to 4.62 (30 years)
• Diversifying economy
Source: WSJ
Accounting for a Debt Issuance
> Elements of an issuance
- Proceeds from issuance
- Premium
- Discount
- Issuance costs
- Other items (accrued interest, rounding, etc.)
- Payments to fiscal agent
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Accounting for a Debt Issuance - Modified Accrual
> Proceeds from issuance
- Other financing source (credit entry)
- Represents the face value / principal value of bonds issued
- Not equal to net debt proceeds (cash received after issuance costs)
> Premium
- Other financing source (credit entry)
- Total gross proceeds > face value
> Discount
- Other financing use (debit entry)
- Face value > total gross proceeds
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Accounting for a Debt Issuance - Modified Accrual
(cont.)
15
> Issuance costs
- Represents costs incurred to issue debt
- Debt service expenditure (debit entry)
• Not always in the fund receiving cash
• Reported in fund incurring cost
- Types of issuance costs
• Underwriter’s discount
• Attorney fees
• Rating agency fees
• Trustee fees
> Other items
- Rounding amount
- Accrued interest
- Good faith deposit
• Receipt of a small portion of proceeds in advance of issuance
• Reported within “bond proceeds”
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Accounting for a Debt Issuance - Modified Accrual
(cont.)
> Journal entry structure
17
Debit Credit
Bond Proceeds XXX
Premium on Bonds Sold XXX
(or – not both!)
Discount on Bonds Sold XXX
Issuance Costs XXX
Cash XXX
Accounting for a Debt Issuance - Modified Accrual
(cont.)
Example:
The Village issued $1,000,000 in general obligation bonds. Gross
proceeds (before payment of issuance costs) totaled $1,250,000.
The underwriter’s discount on the issuance (paid directly out of
proceeds) was $35,000 and costs of issuance were $75,000.
How would we prepare the journal entry to record this debt
issuance?
18
Accounting for a Debt Issuance - Modified Accrual
(cont.)
Example:
Debit Credit
Bond proceeds $1,000,000
Premium on bonds sold 250,000
Issuance costs $ 110,000
Cash 1,140,000
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Accounting for a Debt Issuance - Modified Accrual
(cont.)
Example:
Given that all other information
remained the same, how would our
journal entry change if gross
proceeds totaled $950,000?
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Accounting for a Debt Issuance - Modified Accrual
(cont.)
Example:
Debit Credit
Bond proceeds $1,000,000
Discount on bonds sold $ 50,000
Issuance costs 110,000
Cash 840,000
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Accounting for a Debt Issuance - Modified Accrual
(cont.)
22
Allocations are Often Necessary
Accounting for a Debt Issuance - Modified Accrual
(cont.)
Accounting for Debt Issuance – Full Accrual
How do we treat elements of an issuance
on the full accrual basis of accounting?
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> Proceeds from issuance
- MAB – other financing source
- FAB – liability
> Premium
- MAB – other financing source
- FAB – liability
> Discount
- MAB – other financing use
- FAB – contra-liability
> Issuance costs
- MAB – debt service expenditure
- FAB – debt service expense
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Accounting for Debt Issuance – Full Accrual
> Restricted cash accounts
- Determined by covenants
- Common with revenue bonds issued for utilities, CDA, RDA
- Examples
- Construction account
- Redemption account
- Reserve account
- Depreciation account
- Replacement account
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Accounting for Debt Issuance – Full Accrual (cont.)
Example:
In a previous example, the following journal entry was made to record a
debt issuance in a governmental fund:
Debit Credit
Bond proceeds $1,000,000
Premium on bonds sold 250,000
Issuance costs (expenditure) $ 110,000
Cash 1,140,000
What would our entry be to properly record the issuance on full accrual?
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Accounting for Debt Issuance – Full Accrual (cont.)
Example:
Debit Credit
Cash $1,140,000
Issuance expense 110,000
Long-term liabilities - principal $1,000,000
Unamortized premium 250,000
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Accounting for Debt Issuance – Full Accrual (cont.)
Accounting for Debt Issuance
Where does all of this come from?
> Closing and Post-Sale Report
- Wiring instructions
- Details of issuance costs
- Purchase price
- Par amount of issuance
- Like a lead sheet for your entry
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Refunding
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> When a governmental entity wishes to refinance
existing debt, it has the ability to “refund” current
debt with the issuance of refunding bonds
> Governments can refund debt in order to:
- Obtain lower interest rates
- Push back balloon principal payments
- Smooth out annual debt service
- Modify covenants
- Change variable to fixed rate
Types of Refunding
> Current refunding
> Advance refunding
> Crossover advance refunding
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Guidance for Refundings
> GASB 7 is initial reference and defines some terms
and dictates accounting for refunding at the
governmental fund level (modified accrual)
> GASB 23 provides for the accounting treatment on
full accrual financial statements (proprietary fund
and all government-wide statements)
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Current Refunding
> Proceeds of refunding debt are applied to redeem
existing debt immediately or almost immediately
> “Almost immediately” = Within 90 days of the
issuance of refunding debt
> When not paid out immediately, proceeds are
deposited into escrow or temporarily held by
government issuer
> Reported as an issuance of debt and a payment of
debt principal
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> Journal entry structure
Debit Credit
Bond proceeds XXX
Premium on bonds sold XXX
Discount on bonds sold XXX
Issuance costs XXX
Debt service – principal XXX
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Current Refunding (cont.)
Example:
A village issues refunding bonds for $3,000,000. The village
received an additional premium of $250,000 and incurred total
issuance costs (including underwriter’s discount) of $75,000. The
bonds refunded existing debt with an outstanding principal of
$3,175,000 (redeeming the principal balance on the date of
issuance). How is this transaction recorded?
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Current Refunding (cont.)
Example:
Debit Credit
Bond proceeds $3,000,000
Premium on bonds sold 250,000
Issuance costs $ 75,000
Debt service - principal 3,175,000
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Current Refunding (cont.)
Advance Refunding
> Proceeds of refunding debt are placed in escrow
with a trustee
> Escrow resources make all remaining payments on
refunded debt until maturity date or call date
> Must meet the definition of “in-substance
defeasance”
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Advance Refunding (cont.)
> Defeasance
- Legal defeasance – Debt is legally satisfied based on
certain provisions in the debt instrument even though the
debt is not actually paid
- In-substance defeasance – The government remains
legally obligated, but debt is “as good as paid off”
- Establishment of an escrow account with a trustee may
not be sufficient to legally defease refunded debt, but is
economically equivalent to a legal defeasance
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Advance Refunding (cont.)
> An in-substance defeasance is reported as an advance
refunding if all of the following conditions are met:
- Placement of resources in escrow is irrevocable
- Escrow resources can be used only for scheduled debt service
payments
- Possibility of government having to make future payments is
remote
- All escrow resources are monetary and essentially risk-free
- Cash flows approximate, in timing and amount, scheduled debt
service payments
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Advance Refunding (cont.)
> If one or more of the conditions are not met, the
debt is not defeased
> Both refunding debt and existing debt are required
to be included on the government’s financial
statements
> Resources held in escrow are reported as
“restricted investments”
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Advance Refunding (cont.)
> If refunding debt meets the requirements of in-
substance or legal defeasance, the refunded debt
and resources placed into escrow are removed
from financial statements
> The amount paid into escrow is reported as an
other financing use
- Referred to as “payments into refunding escrow”
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Advance Refunding (cont.)
Example:
A village issues refunding bonds for $3,000,000. The village
received an additional premium of $250,000 and incurred total
issuance costs (including underwriter’s discount) of $75,000. The
net proceeds were deposited into an escrow account, which will
make debt service payments on the refunded debt for 3 years
until the maturity date. How is this transaction recorded?
41
Advance Refunding (cont.)
Example:
Debit Credit
Bond proceeds $3,000,000
Premium on bonds sold 250,000
Issuance costs $ 75,000
Payment into escrow account 3,175,000
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Advance Refunding (cont.)
> For most advance refundings, the amount paid into
escrow does not equal the amount of principal
outstanding and unamortized premium/discount
removed from the balance sheet
> Deferred charge on refunding
- Represents the difference between the incurrence of the
refunding debt and the elimination of refunded debt
- Reported as deferred inflow/outflow of resources
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Advance Refunding (cont.)
Example:
The following journal entry was made to record an
advance refunding in a governmental fund:
Debit Credit
Bond proceeds $3,000,000
Premium on bonds sold 250,000
Issuance costs $ 75,000
Payment into escrow account 3,175,000
If the refunded debt had outstanding principal of $2,750,000 and
unamortized premium of $125,000, what would this entry look like
under full accrual?
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Advance Refunding (cont.)
Example:Debit Credit
Long-term liabilities – principal (new) $3,000,000
Long-term liabilities – premium (new) 250,000
Long-term liabilities – principal (old) $2,750,000
Long-term liabilities – premium (old) 125,000
Deferred charge on refunding (new) 300,000
Issuance costs (new) 75,000
> The deferred charge on refunding is, in practical terms,
a “plug” amount
> In this example, reported as a deferred outflow of
resources
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Crossover Advance Refunding
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> Proceeds placed in escrow make debt service
payments on refunding debt
> Pledged revenues pay debt service on refunded
debt until maturity or call date
> On maturity or call date of refunded debt, pledged
revenues “cross over” to pay debt service on
refunding debt
> Does not meet the requirements of a legal or in-
substance defeasance
Refunding
> Potential New Accounting (Current GASB project)
- Current guidance does not allow for defeasance when
a government places only extinguishing resources with an
escrow agent for the purpose of early
extinguishment of debt.
- Exposure draft expected fall of 2016
- Early deliberations indicate that defeasance of debt will
be allowed when done with existing resources
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Trivia
Question:
What is the projected debt of the federal government by the end of 2016?
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Trivia (cont.)
Answer:
$19.4 trillion
- $59,510/person in US
- 105% of GDP
- 1940 this was $51B, $383/person, and 52% GDP
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Source: Washington Examiner
Annual Debt Service - Governmental Funds
> Two types of debt service payments
- Interest
- Principal
> For bonds, interest is often paid semi-annually
while principal is paid annually
- Based on the agreed-upon payment schedule, principal
may not be paid in a given year
> For leases and other long-term liabilities, the timing
of interest and principal payments can vary
- Monthly, quarterly, semi-annually, annually
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> Only payments due during the fiscal year are
recognized
- No accrual for interest
- Payments made before, but not due until after, the fiscal
year-end are recorded as a prepaid item
> Principal and interest must be reported separately
- Clients will often combine payments into one account
- Reclassifying adjustments may be required to properly
present the debt service expenditures
> Allocations of principal and interest across funds
- Use previously established repayment schedules
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Annual Debt Service - Governmental Funds (cont.)
Annual Debt Service – Full Accrual
How do we report annual debt
activity on the full accrual basis?
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> Debt service is recognized differently on the modified
accrual basis and full accrual basis
> Modified accrual basis – recognized when due
> Full accrual basis – recognized as costs are “incurred”
- Required to record accrued interest for portion of subsequent
interest payments related to the current fiscal year
- Principal payments treated as a reduction of a liability, not an
expenditure/expense
- Debt issuances not recognized as other financing sources/uses;
accrued as a long-term liability
- If material, amortize premiums, discounts, and deferred charges
on refundings
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Annual Debt Service – Full Accrual (cont.)
> Principal payments
- MA – debt service principal (expenditure)
- FA – reduction in long-term liabilities
> Interest payments
- MA – debt service interest (expenditure)
- FA – Interest expense
> Two additional adjustments
- Accrued interest
- Amortization of premium / discount / deferred charge on refunding
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Annual Debt Service – Full Accrual (cont.)
> Accrued interest
- On the MAB, interest is recognized “when due” – accruals are not
recorded for interest unless a payment is due, but unpaid as of
year-end
- On the FAB, interest is recognized as it is “incurred” – an accrual
must be reported for the portion of subsequent interest payments
related to the current fiscal year
- Example – For a fiscal year ending 12/31/16, an interest payment
is made semi-annually with the next payment due on 3/31/17 for
$100,000. As the semi-annual interest payment covers the period
from 10/1/16 through 3/31/17, half of the period covered by the
interest payment occurs in FY16 (equal to $50,000). The
adjustment would be as follows:
Debit Credit
Accrued interest $50,000
Interest expense $50,00055
Annual Debt Service – Full Accrual (cont.)
> Amortization
- Premium and discount represent the difference between the
present value (the gross proceeds) and the face value (the
principal amount) of a debt issuance
- On the MAB, premium and discount are recognized in the year of
issuance
- On the FAB, recognition occurs over the life of the related debt
- Amortization should be determined using a systematic, consistent
approach
• Straight-line method
• Interest method
- Annual amortization is recorded to interest expense
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Annual Debt Service – Full Accrual (cont.)
> Amortization (cont.)
- Deferred charges on refunding are amortized over the life of the
new debt or the life of the refunded debt, whichever is shorter
- Example – If a refunding bond, with principal payments ending in
10 years, is issued and refunds debt for which 5 years of
principal payments remain, the resulting deferred charge on
refunding is amortized over a 5 year period
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Annual Debt Service – Full Accrual (cont.)
> In addition to the adjustments to properly report
debt activity on the full accrual basis, there is an
additional “classification” adjustment
- Long-term liabilities – due within one year
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Annual Debt Service – Full Accrual (cont.)
> Due within one year
- Long-term liabilities must distinguish between amounts
due within one year and amounts due in more than one
year
- For debt, the due within one year amount represents the
total amount of principal scheduled to be paid in the
subsequent fiscal year
- Premium, discount, and deferred charge on refunding are
not considered for the due within one year amount
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Annual Debt Service – Full Accrual (cont.)
Disclosure Requirements
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Disclosure Requirements – Summary of
Significant Accounting Policies (SSAP)
> Description of long-term obligations
> Description of the government’s ability to issue
conduit debt and disclosure of balances, if any
> Disclosure of governmental activities debt used to
finance business-type activities assets
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Disclosure Requirements – Long-Term Obligation Note
> Beginning balances, increases, decreases, ending
balances, and portion due within one year
- By major class of long-term obligation
- Governmental activities and business-type activities
reported separately
> Disclose governmental funds used to liquidate
long-term liabilities other than debt
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> Disclosures for each type of debt
- Original amount of all issuances
- Debt service to maturity disclosed for all issues
• Principal and interest disclosed separately
• Yearly for first five years
• In five-year increments thereafter
- Terms for changes in variable interest rates, if any
- Applicability of federal arbitrage regulations
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Disclosure Requirements – Long-Term Obligation Note
(cont.)
> When a current or advance refunding occurs during
the year
- Provide explanation of refunding debt and refunded debt
defeased/redeemed
- Summary of the difference in debt service requirements
between the refunding debt and the refunded debt
- Disclosure of any economic gain or loss
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Disclosure Requirements – Long-Term Obligation Note
(cont.)
> Outstanding balances of any previously defeased debt
> Any violations of debt covenants, including actions taken
or to be taken to address the violation
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Disclosure Requirements – Long-Term Obligation Note
(cont.)
> Special disclosures for revenue debt
> For each period in which secured debt remains
outstanding, disclose the following information
- Specific revenue pledged and approximate amount of the pledge
• Generally equal to remaining principal and interest on debt
- Identity of and general purpose for which secured debt was issued
- Period during which pledged revenue will not be available for other
purposes
- Ratio of pledged amount to total for the specific revenue, if
estimable
- Comparison of pledged revenues recognized during the period to
the principal and interest payments made during the period for debt
directly or indirectly secured by pledged revenues
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Disclosure Requirements – Long-Term Obligation Note
(cont.)
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Disclosure Requirements – Long-Term Obligation Note
(cont.)
> Special assessment debt disclosures
- Separate from general obligation debt
- Nature of government obligation
• Identify any guarantee, reserve, or sinking fund established to
cover defaults by property owners
- Amount of delinquent special assessments receivable
- If the government is not obligated for special assessment
debt, disclose the amount of debt and indicate that the
government is acting only as an agent and is in no way
liable for the debt
> Capital leases
- Describe all significant lease arrangements
- Gross amount of leased asset, accumulated depreciation,
and current year depreciation expense
- Minimum future lease payments
• For each of the subsequent five years
• Five year increments thereafter
• In total
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Disclosure Requirements – Long-Term Obligation Note
(cont.)
> If subject to legal debt margin, disclose information
on the legal debt limit
> Any material debt authorized and issued after year-
end should be considered a subsequent event
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Disclosure Requirements – Long-Term Obligation Note
(cont.)
Trivia
Question:
In what round of the 1956 draft was QB Bart Starr selected?
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Answer:
17th, 200th overall
Trivia (cont.)
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Question:
To whom did Brett Favre complete his first career pass?
Answer:
Himself, for a loss of 7 yards
Trivia (cont.)
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Question:
Who “invented” the Lambeau Leap ?
Answer:
Leroy Butler
