Chapter Six

Accounting for Debt

Service Fund

Compiled by: Henok Y.

 LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the term debt service fund.

2. Identify purpose of debt service fund.
3. Explain the characteristics of debt service fund.
4. Understand the different types of Long term debts.
5. Explain the sources and uses of cashflows for debt
service fund.
6. Prepare journal entries for Debt Service Fund.
 6.1 Definitions and purposes
❖ Debt Service Funds are governmental funds used to
account for financial resources to be used for payment of
interest and principal on general long-term debt (not
needed for debt paid from proprietary or fiduciary funds).

❖ 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 DSF is created.
 6.1 Definitions and purpose
Purpose Debt Service Funds
❖ To account for and report financial resources that are
restricted, committed, or assigned to expenditure for
principal and interest on general long-term liabilities.

DSFs required :only if

➢ they are legally mandated or

➢ Financial resources are being accumulated for principal and

interest payments maturing in future years.
 6.2 Characteristics of debt service fund
❖ DSF is used to account for both the repayment of the
principal and interest of the long-term debt when they are
due.
❖ DSF are governmental funds and therefore are
Expendable.
❖ As expendable funds, DSF use the modified accrual basis
of accounting.

❖ Like GF and SRF budgetary accounts such as estimated

revenue, estimated other financing sources,
appropriations, estimated other financing uses,
revenues, and expenditures, are used.
 6.2 Characteristics of debt service fund
❖ There is no Encumbrance account because the operations
of DSF do not involve the use of purchase orders and
contracts for goods and services.

❖ The ledger accounts of Debt Service fund includes liquid

assets and current liabilities and Fund Balance Accounts.

❖ 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.
 6.2 Characteristics of debt service fund
❖ Use modified accrual: Expenditures for interest and
principal are generally recognized in period in which they
are legally due.

❖ If taxes are levied by the debt service fund, record

Estimated Revenues in the budget entry and use the same
property tax accounting as for the General Fund

❖ If taxes are levied by the General Fund and transferred to

the debt service fund, record Estimated Other Financing
Sources in the budget entry and Inter fund Transfers In
(an Other Financing Sources account) for the transfer.
 6.2 Characteristics of debt service fund
❖ 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 require DSF accounting to be on the same

basis as is required for general and Special Revenue Funds.

❖ One peculiarity of the modified accrual basis used by

the governmental fund types which only relates to DSF
is that, interests on long term debt is not accrued.
 6.3 General long term liabilities
❖ GLTL consist of an expected outflow of resources arising
from present obligations that are not payable within a year
or the operating cycle of the company. They arise from the
activities of governmental funds, not accounted for as
liabilities of a proprietary or fiduciary funds.

❖ General long-term liabilities are obligations of the units and

not of the individual funds.

❖ In order to bring such debt under accounting control, the

general long-term debt Account Group (GLTDAG) is
created.
 6.3 General long term liabilities
Types of General Long-term Liabilities
❖ A bond is a long-term contract under which a borrower
agrees to make payments of interest and principal, on
specific dates, to the holders of the bond.

❖ It is a written promises made to bondholders to pay a

specified principal sum at a specified future date with
interest described in a document called a bond indenture.

❖ The bond indenture or agreement often includes the

amounts authorized to be issued, interest rate, due date(s),
call provisions, property pledged as security, sinking fund
requirements, working capital and dividend restrictions etc.
 6.3 General long term liabilities
❖ All long term debts of governmental units consists of one
of the following two basic types of bonds;

❖ Term 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- these are bonds, which have periodic

maturities. The principal of a serial bond so repaid at
various determined dates over the life of the issue.
 6.3 General long term liabilities
There are four types of serial bonds;
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.

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.

Annuity Serial Bond- if the amount of annual principal repayment is

scheduled to 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.

Irregular Serial Bonds- these types of serial bonds may have pattern of
repayment that does not fit the other three categories.
 6.3 General long term liabilities
❖ Generally, there are other type of long-term debts (bonds) which also
arise because of different activities of Governmental units. These long
term debts may or may not be accounted for under DSF for their
repayment. They may be categorized as follows;

➢ Revenue 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.

➢ General Obligation 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.
 6.3 General long term liabilities
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).
➢ All other long-term debt fitting into one of the two
preceding categories is shown as a liability of the
GLTDAG. 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 group c above. DSF account for the matured
portion and the repayment of such principal and interest on
such long term debt.
 6.3 General long term liabilities
❖ Liabilities normally have credit balances, it is therefore
necessary to create a debit account to balance the account
group in much the same manner as GFAAG is balanced by
the “Investment in ...”.
• There are two categories of these debit accounts:
1.Amounts which have been accumulated in the DSF for
repayment of General Long Term Debt i.e the amount that
the entity has,

2.Amounts that must be provided in future years for the

repayment of long-term debt.
 6.3 General long term liabilities
❖ It is prompted that governmental fund types (General,
special revenue, capital projects, debt service, and
permanent funds) account for only short-term liabilities to
be paid from fund assets.
❖ Although, the proceeds of long-term debt may be placed in
one of these fund types (usually a capital projects fund),
the long-term liability itself must be recorded in the
governmental activities accounting records at the
government-wide level.
❖ Proprietary funds and perhaps certain private-purpose
trust funds account for both long-term debt serviced by
the fund and short-term debt to be repaid from fund
assets.
 6.3 General long term liabilities
❖ For regular serial bonds, the resources raised each
year approximate debt service requirements, thus
investments will be minimal. However, any idle cash
balances should be invested
❖ For deferred serial bonds, some resources are likely to be
raised and invested during the years before the first
principal payment becomes due.
❖ 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.
❖ DSF may also be used to make periodic payments required
by capital lease agreements.
 6.4 Sources and uses of cash flows for DSF
Sources of finances (resources) for DSF
❖ 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 resource 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.
 6.4 Sources and uses of cash flows for DSF
Sources of finances (resources) for DSF
❖ Investments: for a term bond issue the assets that are
accumulated in the DSF will be invested in income
producing securities. The investment income is to be
accounted In the DSF as revenue.

❖ Refinancing: it may be possible to use the proceeds of the

sinking 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.

The process of issuing new bonds to pay of the old ones is

called refinancing.
 6.4 Sources and uses of cash flows for DSF
Sources of finances (resources) for DSF
❖ 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.

❖ 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.
 Illustrative Case on DSF
Assume the bonds issued by the Town of Brighton as
partial financing for the fire station construction project
are regular serial bonds maturing in equal annual amounts
over 20 years are registered as to interest and principal.
The total face value of the issue was $1,200,000; all
bonds in the issue bear interest of 6 percent per year,
payable semiannually on June 15 and December 15. The
bonds were dated June 15, 2014, and sold on that date at
par. During 2014 the only expenditure the debt service
fund will be required to make will be the interest payment
due December 15, 2014, in the amount of $36,000
($1,200,000 x 0.06 x ½ year).
Assuming that revenues to pay the first installment
of bonds due on June 15, 2015, and both interest
payments due in 2015 will be raised in 2015 from a
special sales tax, the budget for 2014 need only
provide resources in the amount of the 2014 interest
expenditure. The entry to record the budget for the
year ended December 31, 2014, including $6,000
residual equity to be transferred from the Fire
Station Capital Projects Fund, is:
 Estimated Revenues 30,000

Estimated Other Financing Sources 6,000

Appropriations 36,000

If sales tax revenues in the amount of $31,200 were

collected in cash for debt service, the entry is:

Cash 31,200

Revenues 31,200
The $6,000 residual equity of the Fire Station Capital
Projects Fund was transferred to the debt service fund. The
entry required in the latter fund is:

Cash 6,000
OFS-Inter fund Transfers In 6,000

On December 15, 2014, when the first interest payment is

legally due, the debt service fund records the expenditure of
the appropriation:

Expenditures-Bond Interest 36,000

Interest Payable 36,000
Checks totaling $36,000 are written to the registered
owners of these bonds. The entries to record the
payment in the debt service fund is:
Interest Payable 36,000
Cash 36,000
All budgetary and operating statement accounts are
closed by the following entry:
Revenues 31,200
OFS-Inter fund Transfers In 6,000
Appropriations 36,000
Estimated Revenues 30,000
Estimated Other Financing Sources 6,000
Expenditures Bond Interest 36,000
Fund Balance 1,200
Second-Year Transactions:

In the second year of the Serial Bond Debt Service Fund,

the fiscal year ending December 31, 2015, the following
journal entries would be required.

The special sales tax for debt service estimated to produce

revenues of $135,000 for the year. From these revenues,
two interest payments (the interest due on June 15, 2015,
and December 15, 2015) of $36,000 and $34,200,
respectively, and a principal redemption payment of
$60,000 due on June 15, 2015, must be paid.
The entry required at January 1, 2015, to record the

budget for FY 2015.

Estimated Revenues 135,000
Appropriations 130,200
Fund Balance 4,800

During the year, actual revenues from the special sales tax were $134,100. The following entries
summarize these collections:

Cash 134,100
Revenues 134,100
On June 15, 2015, interest of $36,000 and the first
redemption of principal in the amount of $60,000
($1,200,000 ÷20 years) were paid to bondholders of
record, as shown below:
Expenditures-Bond Principal 60,000
Expenditures- Bond Interest 36,000
Cash 96,000
The semiannual interest payment due on December 15,
2015, was paid on schedule, as reflected in the following
entries, based on a remaining principal of $1,140,000 at 6
percent interest per annum.
Expenditures⎯Bond Interest 34,200
Cash 34,200

All temporary accounts of the debt service fund were closed on December 31, 2015, as shown
below.

Revenues 134,100
Appropriations 130,200
Fund Balance 900
Estimated Revenues 135,000
Expenditures⎯Bond Interest 70,200
Expenditures⎯Bond Principal 60,000
The End of Chapter 6

Thank You!!!