Chapter Five

Accounting for Debt Service Funds

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).

From time to time governmental entities have a shortage of cash to carry out their activities. In
such cases, governmental entities may turn to borrowing to supply the needed cash. This
especially is true when cash is needed for capital projects. 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 Debt Service Fund is created.

Characteristics:
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.
Debt Service Funds are governmental funds and therefore are 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.
As expendable funds, DSF use the modified accrual basis of accounting. An application
of modified accrual, which is of 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 1, 2015 would not be accrued
and recorded on December 31, 2014 Balance Sheet.
Accounts recommended for use by Debt Service Funds are similar to but not exactly the
same as those recommended for use by the General Fund and Special Revenue Funds.
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Because the number of sources of revenues and other financing sources is relatively small
in a typical Debt Service Fund, as is the number of purposes for which expenditures are
made, it is generally not necessary to use control and subsidiary accounts such as those
used by the General Fund. Moreover, because debt service funds do not issue purchase
orders or contracts for goods and services, the use of encumbrance accounting is
unnecessary. Thus, the budgetary accounts typically used for a debt service fund are
Estimated Revenues, Estimated Other Financing Sources, Appropriations, Estimated
Other Financing Uses, and Budgetary Fund Balance. The actual operating accounts
usually include only a few revenue accounts, Other Financing Sources (for inter fund
transfers in and bond issue premiums), Expenditures_ Bond Interest, Expenditures_ Bond
Principal, and, in the case of certain bond refunding transactions, Other Financing Uses.
Similarly, relatively few balance sheet accounts are found in a Debt Service Fund.
Accounts typically include current asset accounts such as Cash, Investments, Taxes
Receivable (and related estimated uncollectible accounts), and Due from Other Funds.
Liability accounts might include Matured Bond Interest Payable and Matured Bond
Principal Payable. Fund equity typically consists of a single Fund Balance account. For
the convenience of bondholders, the payment of interest and the redemption of matured
bonds are ordinarily handled through the banking system. Usually the government
designates a bank as ‘‘paying agent’’ or ‘‘fiscal agent’’ to handle interest and principal
payments for each issue. Therefore, the assets of a Debt Service Fund often include
“Cash with Paying (or Fiscal) Agent” and the appropriations, expenditures, and
liabilities may include amounts for the service charges of 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 a legitimate charge
against investment revenues.
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.

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Types of Long Term Debts
Bonds are written promises to pay a specified principal sum at a specified future date with
interest. They are typically issued in 1000 and 5000 denominations. All long term debts of
governmental units consist of one of the following two basic types of bonds;

Term Bonds: These 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 pre determined dates over the life of the issue. There are four types of serial
bonds;
1) If the total principal of an issue is repayable in a specified number of equal annual
installments over the life of the issue, it is a regular serial bond issue.
2) If the first installment is delayed for a period of more than one year after the date of the
issue but thereafter installments fall due on a regular basis, the bonds are known as
deferred serial bonds.
3) If the amount of annual principal repayments is scheduled to increase each year by
approximately the same amount that interest payments decrease (interest decreases, of
course, because the amount of outstanding bonds decreases) so that the total debt service
remains reasonably level over the term of the issue, the bonds are called annuity serial
bonds.
4) Irregular serial bonds may have any pattern of repayment that does not fit the other
three categories.

Number of Debt Service Fund

Although each issue of long term or intermediate term debt has a separate obligation and may
have legal restriction and servicing requirements that differ from other issues, GASB’s standards
provide that, if legally permissible a single debt service fund be used to account for the services
of all issues of tax supported and special assessment debt. If legal restrictions do not allow the
services of all issues of tax supported and special assessment debt to be accounted for by a single

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Debt Service Fund, as few additional Debt Service Funds as in consistent with applicable laws
should be created.

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.
 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. 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.
 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.

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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 and/or installments 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 of 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 shown on the sources 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 modified 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, 2015 and the interest on its bond is payable
on January 1 and July 1 of each year, the amount payable on January 1, 2016 would not be
considered a liability in the Balance sheet of The Debt Service Fund prepared as of December
31, 2015. The rationale for this recommendation is that the interest is not legally due until
January 1, 2016. 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

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before. In the event 2015 appropriations include January 1, 2016 interest and /or principal
payment, the appropriations expenditures (and resulting liabilities) should be recognized in 2015.

Persons budgeting and accounting for DSF should seek competent legal advice on the permit
able use of both premium on debt sold & residual equity transfer. In 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.

Use of General Fund to Account for Debt Service

In some jurisdictions, laws do not require accounting for the debt service function 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 financial reporting standards discussed in this
chapter should be followed for the debt service activities of the General Fund.

Illustrative Cases on DSF:

Illustration 1:
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:

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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
Other Financing Sources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
Other Financing Sources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

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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

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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

In subsequent years, the pattern of journal entries will be the same as that of the preceding
entries, except that actual sales taxes realized will vary from year to year and the amount of
interest will decline each year as the principal is reduced. If revenues are insufficient in any year
to meet debt service requirements, available fund balance can be used to augment current year
revenues. If fund balance is insufficient to cover the shortfall, then an inter fund transfer from the
General Fund would likely be used. Making all interest and principal redemption payments by
their due date is critically important as a missed or late payment could adversely impact the
entity`s bond rating and significantly increase future borrowing costs.

Illustration 2:
The town of X uses a serial bond Debt Service Fund to pay off matured bonds and interest
payable amounts.

Information about the bond issue is as follows:

Principal amount________________ Birr 1,000,000
Interest rate____________________ 10 %
Bonds dated____________________ January 1, 20x6
Interest payable__________________ January 1 & July 1; Beginning July 1, 20x7
Bonds mature serially at the rate of Birr 100,000 a year starting January 1, 20x7.
The fiscal year (FY) runs from July 1, 20x7 - June 30, 20x8.

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1) The revenue budget for serial bond Debt Service Funds for the FY ended June 30, 20x8
consists of estimated revenues of Birr 330,000 to be raised from debt service tax levy and
estimated revenues of Birr 50,000 from earnings on investments.

=> Appropriation budget for the FY ended June 30, 20x8 includes matured interest payable and
matured bonds payable i.e.

Interest for July 1,20x7 and January 1,20x8 = (Birr 900,000 x 0.1 x ½ year) * 2 = Birr 90,000
Bonds payable mature January 1,20x8 = Birr 100,000

Estimated Tax Revenue Birr 330,000

Estimated Investment Revenue 50,000
Appropriations Birr 190,000
Fund Balance 190,000

2) Taxes receivable in the amount of Birr 340,000 and estimated uncollectable taxes in the
amount of Birr 10,000 are recorded.
Taxes Receivable- current Birr 340,000
Allowance for uncollectable- current taxes Birr 10,000
Revenues 330,000

3) Half of the gross levy of taxes is collected in cash.

Cash Birr 170,000

Tax Receivable-current Birr 170,000

4) Interest payable on July 1, 20x7 is recorded as a liability.

Expenditure_ Bond Interest Birr 45,000

Interest Payable Birr 45,000

5) Checks are written and mailed to the paying agent for the interest payment due on July 1,
20x7.

Cash with fiscal agent Birr 45,000

Cash Birr 45,000

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6) Interest is paid by the fiscal agent and the fiscal agent fee of 500 is paid.

Interest Payable Birr 45,000

Expenditure_ service charge 500
Cash with Fiscal agent Birr 45,000
Cash 500

7) Taxes in the amount of Birr 160,000 are collected.

Cash Birr 160,000

Tax Receivable- current Birr 160,000

8) Cash of Birr 100,000 is invested in a short term note which bears an interest rate of 10%.

Short Term Investment- Note Birr 100,000

Cash Birr 100,000

9) Interest on investment is received for the last four months.

100,000 x 10% x 4/12 = 3333.33

Cash Birr 3333.33

Revenue Birr 3333.33

10) Checks are written and mailed to the fiscal agent for the matured bonds and interests due on
January 1, 20x8.

Cash with fiscal agent Birr 145,000

Cash Birr 145,000

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11) On January 1, 20x8 matured bonds and interests of Birr 145,000 and the fiscal agent’s fee of
Birr 1,000 is charged as Expenditure.

Expenditure_ bond principal Birr 100,000

Expenditure_ bond interest 45,000
Expenditure_ service charge 1,000
Bonds Payable Birr 100,000
Interest Payable 45,000
Fiscal agent fee payable 1,000

12) Matured bonds and interests are paid by the fiscal agent and the fiscal agent fee is paid.

Bond Payable Birr 100,000

Interest Payable 45,000
Fiscal Agent Fee Payable 1,000
Cash with fiscal agent Birr 145,000
Cash 1,000

13) Interest on Investment is received for the last three months.

100,000 x 10% x 3/12 = 2,500

Cash Birr 2,500

Revenue Birr 2,500

14) At June 30, 20x8 interests on investment are accrued for two months.
100,000 x 10% x 2/12 = 1666.67

Interest Receivable Birr 1666.67

Revenue Birr 1666.67

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 Town of X Serial Bond DSF
Trial Balance
June 30, 20x8

Account Title Debit Credit

Cash Birr 44,333.33
Short Term Investment-Treasury Bills 100,000.00
Interest Receivable 1,666.67
Tax Receivable-current taxes 10,000.00
Allowance for Uncollectable-current taxes Birr 10,000
Unreserved and Undesignated Fund Balance -
Tax Revenue 330,000
Investment Revenue 7,500
Expenditures_ bond principal 100,000
Expenditures_ bond interest 90,000
Expenditures_ service charge 1,500
Estimated Tax Revenue 330,000
Estimated Investment Revenue 50,000
Appropriations 190,000
Budgetary Fund Balance 190,000
Total Birr 727,500 Birr 727,500

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 Town of X Serial Bond DSF
Statement of Revenue, Expenditure & Change in Fund Balance
For The Year Ended June 30, 20x8
Revenues:
Tax Revenue Birr 330,000
Investment Revenue 7,500
Total Revenues Birr 337,500
Expenditures_ bond principal 100,000
Expenditures_ bond interest 91,000
Expenditures_ service charge 1,500
Total Expenditures Birr 191,500

Excess of Revenue over (under) Expenditure 146,000

Add: Fund Balance, July 1, 20x7 -0-
Fund Balance, June 30, 20x8 Birr 146,000

Town of X Serial Bond DSF

Balance Sheet
June 30, 20x8
Assets:
Cash Birr 44,333.33
Short Term Investment- Note 100,000.00
Interest Receivable 1,666.67
Tax Receivable-current taxes 10,000
Less: Allowance for Uncollectable-current Taxes 10,000 -0-
Total Assets Birr 146,000
Liabilities and Fund Balance:
Fund Balance Birr 146,000
Total Liabilities and Fund Balance Birr 146,000

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Closing Entries:

Appropriations Birr 190,000

Budgetary Fund Balance 190,000
Estimated Tax Revenue Birr 330,000
Estimated Investment Revenue 50,000
(To close budgetary accounts)

Tax Revenue Birr 330,000

Investment Revenue 7,500
Expenditures_ bond principal Birr 100,000
Expenditures_ bond interest 91,000
Expenditures_ service charge 1,500
Fund Balance 146,000
(To close operating statement accounts)

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