CHAPTER FIVE

Accounting for General Long Term Liabilities and Debt Service Fund
5.1 General Long Term Liabilities
The use of long-term debt is a traditional part of the fiscal policy of state and local governments,
particularly for financing the acquisition of general capital assets. Although some governments
have issued taxable debt, the interest earned on most debt issued by state and local governments
is exempt from federal taxation and, in some states, from state taxation. The tax-exempt feature
enables governments to raise large amounts of capital at relatively low cost.
General long-term liabilities are those that arise from activities of governmental funds and that
are not reported as fund liabilities of a proprietary or fiduciary fund. General long-term liabilities
are reported as liabilities in the Governmental Activities column of the government wide
statement of net assets but are not reported as liabilities of governmental funds.
Long-term liabilities include obligations arising out of financing activities, such as the issuance
of bonds and notes, and capital leases. In addition, long-term liabilities can arise out of the
operating activities of governments. Examples of long-term liabilities related to operating
activities include claims and judgments, compensated absences, pensions and other post-
employment benefits, and obligations related to landfills and pollution remediation.
When studying this chapter, the reader is reminded 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. The proceeds/continues 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.
As we just observed, major capital assets are commonly financed through bond or other debt
issues. Another fund type, the debt service fund, is used to account for financial resources that
are intended to provide payments of interest and principal as they come due. Debt service funds
are not created for debt issues where the activities of proprietary funds are intended to generate
sufficient cash to make interest and principal payments.
If taxes or special assessments are levied specifically for payment of interest and principal on
long-term debt, those taxes are recognized as revenues of the debt service fund. More

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commonly, undesignated taxes are levied by the General Fund and transferred to a debt service
fund to repay debt. In that case, the taxes are recorded as revenues by the General Fund and as
transfers to the debt service fund. Because the amounts of bond issues and the associated capital
projects are often approved by the voters, bond premiums and unexpended capital project
resources are generally required by state law to be transferred to debt service funds.
5.2 Debt Service Fund
When long-term debt has been incurred for capital or other purposes, revenues must be raised in
future years to make debt service payments. Debt service payments include both periodic interest
payments and the repayment of debt principal when due. Revenues from taxes that are restricted
for debt service purposes are usually recorded in a debt service fund, as are subsequent
expenditures for payments of interest and principal. A debt service fund is used only for debt
service activities related to general long-term liabilities—those reported in the Governmental
Activities column of the government-wide statement of net assets. Debt service related to long
term liabilities reported in proprietary and fiduciary funds is reported in those funds, not in a debt
service fund.
5.2.1 Number of debt service fund
In addition to debt service fund for bond liabilities, debt service funds may be required to service
debt arising from the use of notes or warrants having a maturity more than one year after date of
issue. Debt service funds may also be used to make periodic payments required by capital lease
agreements.
Although each issue of long-term or intermediate-term debt is a separate obligation and may
have legal restrictions and servicing requirements that differ from other issues, GASB standards
provide that, if legally permissible, a single debt service fund may be used to account for the
service of all issues of tax-supported and special assessment debt.
5.2.2 Use of general fund to account for debt service
In some jurisdictions, laws do not require the Debt Service Fund function to be accounted for by
a debt service fund. Unless the Debt service function is very simple, it may be argued that good
financial management would dictate the establishment of a debt service fund even though not
required by law if neither law nor sound financial administration requires the use of debt service
funds, the function may be performed within the accounting and budgeting framework of the
General fund. In such cases, the accounting and the financial reporting standards discussed in

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this chapter should be followed for the debt service activities of the General fund to the extent
consistent with local laws.
5.2.3 Budgeting for Debt Service Fund
Whether or not additions to Debt service Funds are required by the Bond indenture to be
approximately equal year by year, good politics and good financial management suggest that the
burden on the tax payers be spread reasonably and evenly rather than lumped in the years that
issues or instalments happen to mature. If Taxes for payment of interest and principal on long
term debt are to be raised directly by the DSF, they are recognized as revenues of the DSF. If
Taxes are to be raised by another fund and transferred to the DSF, they must be included in the
Revenues budget oh the fund that will raise the revenue (often the General Fund) and also
budgeted by that fund as Operating transfer to the DSF. Since the Debt Service fund is a
budgeting and accounting entity it should prepare Revenues and Other Financing Sources Budget
that includes operating transfers from other fund. As well as revenues it will raise directly from
Earnings on its Investments. Although the items may be difficult to budget accurately, DSF can
often account on receiving Premium on Debt Issues Sold and Accrued Interest on Debt Issues
Sold. Premium and Accrued Interest on Debt Issues Sold are considered Revenues of the
recipient DSF. Similarly as indicated in the previous chapter and on the shown on the services of
finance previously, if Capital projects are completed with expenditures less than Revenues and
Other Financing Sources, the residual Equity is ordinarily transferred to the DSF
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 currently
require DSF accounting to be on the same basis as is required for general and Special Revenue
Funds. One peculiarity of the accrual basis used by the governmental fund types which only
relates to DSF is that, interests on long term debt is not accrued. For Example: If the fiscal year
of a governmental units ends on December 31, 20x5 and the interest on its bond is payable on
January 1 and July 1of each year, the amount payable on January 1, 20x6 would not be
considered a liability in the Balance sheet of The Debt Service Fund prepared as of December
31, 20x5. The rationale for this recommendation is that the interest is not

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Legally due until January 1, 19x6. The same reasoning applies to principal amounts that mature
on the first day of the fiscal year; they are not liabilities to be recognized in statements prepared
as of the day before.
In the events 20x5 appropriations include January 1, 20x6 interest and /or principal payments,
the appropriations expenditures (and resulting liabilities) should be recognized in 20x5.
Persons budgeting and accounting for DSF should seek competent legal advice on the permit
table use of both premium on debt sold & residual equity transfer. In the some cases, one or both
of these items must be held for eventual debt repayment and may not be used for interest
payments. In other cases both Premium Revenue and Residual Equity Transfer- In may be used
for interest payments.
5.2.4 General outline of debt service fund characteristics
1. Debt service fund is used to account for both the repayment of the principal and payment of
interest of the long-term debt when they are due. Often Debt service funds are legally
mandated. Other times, the government administrator might think a Debt Service Fund is
useful for management of resources being accumulated for Debt Service.
2. DSF is governmental funds and therefore is Expendable. Although, 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. Often they
arise from the Capital projects. Proprietary funds also borrow on a long term basis, but their
repayment is accounted for in the proprietary fund itself rather than a separate debt service
fund.
3. As expendable funds, DSF use the modified accrual basis of accounting. An application of
modified accrual, which is special interest to DSF, has to do with interest payable. Interest
payable is not accrued in the DSF. It is only recorded as a liability in the period when it
becomes due. For example, interest due on January 31, 20x1 would not be accrued and
recorded on December 31, 20 x 0 Balance Sheet.
4. Accounts recommended for use by a serial bond Debt service fund is similar with that of
General Fund and Special Revenue fund. Even if it is not exactly the same such as budgetary
accounts (Estimated Revenue, Estimated Other Financing
Sources, Appropriations, Estimated other financing Uses) or proprietary accounts
(Revenues, OFS, Expenditures, OFU)

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5. The operations of DSF do not involve the use of purchase orders and contracts for goods and
services. So the Encumbrance accounting is not needed.
6. The ledger account of a Serial Bond Debt Service fund includes liquid assets and current
liabilities and Fund Balance Accounts. Liquid Assets of serial Bond Debt Service funds are
held for the purpose of paying interest or outstanding bonds and retiring the principal
instalment s as they fall due; for the convenience of the bond holders, the payment of interest
and the redemption of matured bonds is ordinarily handled through the Banking system.
Usually the government designate a bank as a “Paying Agent” or a “Fiscal Agent” to handle
interest and principal payments for each issue. The assets of a Debt service Fund may
therefore include Cash with paying Agent and the appropriations, Expenditures and
liabilities may include Amounts for the Services and Charges for Paying Agents.
Investment Management may be performed by governmental employees or by banks, brokers
or others who charge for the service, Investment management fees are legitimate charges
against Investment Revenues.
7. Timing of Debt Service payments - mostly due to both political and financial management
considerations, the payment should be kept consistent over the life of the issue. With serial
bonds this is easy but with term bonds, it takes planning (the type of long term bonds will be
discussed later in this topic).

5.2.5 Types of Governmental Bonds

There are different types of long-term debt issued by governmental entities.
There are two types of bonds i.e. serial and term bonds
Bond is a written promise to pay a specified sum of money, called the face value or principal
amount, at a specified date or dates in the future, called the maturity dates, together with periodic
interest at a specified rate. Note that the difference between a note and a bond is that the latter
runs for a longer period of time and requires greater legal formality.
Serial Bonds - this are bonds, which have periodic maturities. The principal of a serial bond so
repaid at various ore/elements determined dates over the life of the issue. There are four types of
serial bonds;
1. Regular Serial Bonds- The total Principal amount of an issue is repayable in a specified
number of equal annual instalments/repayments over the life of the issue.

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2. Differed Serial Bond- If the first installment is delayed/late for a period of more than one
year after the date of the issue but thereafter installments fall due on a regular basis.
3. Annuity Serial Bond- If the amount of annual principal repayments is scheduled to increase
each year by approximately the same amount that interest payments decrease (interest
decreases because the amount of outstanding bonds decreases) so that the total debt service
remains reasonably level over the term of the issue.
4. Irregular Serial Bonds- these types of serial bonds may have pattern of repayment that does
not fit/appropriate the other three categories.

Generally, there are other types of long-term debts (bonds) which also arise because of different
activities of Governmental units. This long term debts may or may not be accounted for under
DSF for their repayment. They maybe categorized as follows;

a. Revenue Bonds- are issued to finance the establishment or expansion of activities

Accounted for in Enterprise Funds (EF). These bonds are shown as liabilities of EF. Because
their repayment and servicing can only come from money generated from the operations of those
funds.
b. General Obligation Bonds- these 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. 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).
c. All other long-term debt fitting into one of the two preceding categories is shown as a
liability of the GLADAG. 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 un-matured
long term debt in group above. DSF account for the matured portion and the repayment of
such principal and interest on such long term debt.
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. Additionally, DSF may also be used to make periodic payments required by capital
lease agreements.

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 5.2.6 Budgeting for Debt Service Fund and Sources of finances (resources)
1. Special Taxes- Special Taxes are not unusual/unfamiliar 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.
2. Investments- for a term bond issue the assets that accumulate in the DSF will be invested in
income producing securities. The investment income is to be accounted in the DSF as
Revenue.
3. 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. If market interest fall later on, it may
be advisable to issue new bonds for the outstanding debt and use that money plus whatever is
in the sinking fund to retire the old Bonds. The process of issuing new bonds to pay of the
old ones is called Refinancing.
4. 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.
Accrued interest on bond sold means that accrued revenue, revenues earned but not yet
received in cash or recorded and accrued expense, expenses incurred but not yet paid in cash
or recorded.
5. 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.
5.2.7 Accounting for regular serial bond
“Illustrative Transactions—Capital Projects Funds”) are regular serial bonds maturing in equal
annual amounts over 20 years. The total face value of the issue was $1,200,000; all bonds in the
issue bear interest of 6 precent per year, payable semi-annually. During 2011 the only

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expenditure the debt service fund will be required to make will be the interest payment due
December 15, 2011, in the amount of $36,000 ($1,200,000 * 0.06* 1/2 year). Assuming that
revenues to pay the first instalment of bonds due on June15, 2012, and both interest payments
due in 2012 will be raised in 2012 from a special sales tax, the budget for 2011 need only
provide resources in the amount of the 2011 interest expenditure.
1. The entry to record the budget for the year ended December31, 2011, including $6,000
residual equity to be transferred from the Fire Station Capital Projects Fund, is:

2. If sales tax revenues amount of $31,200 are collected in cash for debt service the entry is:

3. 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:

Governmental activities at the government-wide level are unaffected since the transfer is
between two funds within the governmental activities category.
On December 15, 2011, when the first interest payment is legally due, the debt service fund
records the expenditure of the appropriation and the corresponding entry is made to record
interest expense at the government-wide level:

4. Checks totalling $36,000 are written to the registered owners of these bonds. The entries to
record the payment in the debt service fund and governmental activities general journals are:

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5. As of December 31, 2011, an adjusting entry would be made to accrue one-half of a month’s
interest expense ($1,200,000 * 0.06 *1/12 * 1/2) on the accrual basis at the government-wide
level, as would be the case in accounting for business organizations.

6. All budgetary and operating statement accounts are closed by the following entries:

7. . In the second year of the Serial Bond Debt Service Fund, the fiscal year ending December 31, 2012,
the following journal entries would be required. The special sales tax for debt service is estimated to
produce revenues of $135,000 for the year.

8. During the year, actual revenues from the special sales tax were $134,100. Entries summarize these
collections.

9. On June 15, 2012, 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 in Entries

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10. The semi-annual interest payment due on December 15, 2012, was paid on schedule, as
reflected in Entries 11a and 11b, based on a remaining principal of $1,140,000 at 6 percent
interest per annum.

11. On December 31, 2012, interest expense and interest payable were accrued in the amount of
$2,850 ($1,140,000 *.06 * 1/12 * 1/2):

12. All temporary accounts of the debt service fund were closed on December 31, 2012, as
shown in Entries 13a and 13b.

5.2.8 Accounting for Term Bonds

Term bond issues mature in their entirety on a given date, in contrast to serial bonds, which
mature instalments. Required revenues of term bond debt service funds may be determined on an
“actuarial” basis or on less sophisticated bases designed to produce approximately level
contributions during the life of the issue. Revenues and other financing sources of this particular
debt service fund are assumed to be property taxes levied directly for this debt service fund and
earnings on investments of the debt service fund.
Tax revenue must be sufficient to cover each bond interest payment of $37,500 ($1,500,000, the
face value of the bonds,* 5 percent, the annual nominal interest rate,* 1/2 year).

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For 2011, the second year of the Term Bonds Debt Service Fund’s operation, the actuarial
assumption is that the fund will earn 6 percent per year, compounded semiannually; the required
earnings for the year amount to $3,056.19 (see footnote 5 for calculation). Therefore, Estimated
Revenues is debited for $117,843.33 ($114,787.14 + $3,056.19). The appropriations budget
would include only the amounts becoming due during the budget year, $75,000 (two interest
payments, each amounting to $37,500). The entry to record the budget for fiscal year 2011
follows.

2. Assuming that collection experience of the Town of Brighton indicates that a tax levy in the
amount of $120,000 is needed in order to be reasonably certain that collections during each
six-month period will equal the needed amount, the entries to record the levy and the
expected un-collectibles amounting to $3,000 are as follows:

3. The required interest payment was made on January 1, 2011, as reflected in Entries 3a and
3b.

4. Actual tax collections during the first six months of FY 2011 were $57,400.Entries 4 and 5
would be required in the journals of both the debt service fund and governmental activities to
record the collections and subsequent addition to sinking fund investments at June 30, 2011.

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6. Entries 6a and 6b record the addition of $1,261.99 of interest on June 30, 2011, which is
added to the Investments account.

7. The interest payment of $37,500 due on July 1, 2011, was made as scheduled, as shown in Entries

8. property tax collections for debt service on the term bonds totaled $58,000 and the required addition
to the sinking fund investments account was made on December 31, 2011, as shown in Entries

10. December 31, 2011, interest of $37,500 on the term bonds was accrued at the government-
wide level for the second six months of the year.

11. Interest earnings on sinking fund investments for the second six months of the year were recorded in the amount
of $1,883.10, as shown in Entries.

12. Property tax accounts as taxes Receivable—Delinquent.

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13. All budgetary and operating statement accounts of the Term Bond Debt Service Fund were
closed at December 31, 2011, as shown in Entries. Related closing entries for governmental
activities.

5.3 Financial Reporting

Debt service activities are reported as part of governmental activities at the government wide
level. The column of the balance sheet governmental funds and the statement of revenues,
expenditures, and changes in fund balances—governmental funds. ILLUSTRATION

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