Chapter 7

Accounting for Debt Service Fund

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 Accounting for Debt Service Fund
 Governmental entities might face cash shortage while
they carry their regular activities. In such a case, these
Governmental entities may issue general obligation debt
in the form of liabilities usually bonds that are secured
by the full faith and credit of the governmental unit.
 The payment of the principal and interest should be
well planned in advance and made timely.
 The payment of principal and interest on debt is called
servicing the debt.

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6.2.1 Characteristics of Debt Service Fund
 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.
 Debt service fund are government funds and therefore, are
expendable.
 Debt service funds are for general long-term debt which has been
used to provide resource for one of the other government funds.
Debt service fund use modified accrual basis. An application of
modified accrual basis has to do with interest payable. Interest
payable is not accrued in the debt service fund. It is only recorded
as liability in the period when it becomes due. For example,
Interest due on January 31, 2008 would not be accrued and
recorded on December 31, 2008 balance sheet.
 Accounts recommended for use by Debt service fund are almost
similar
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 Contd………
 The operations of Debt service fund do not involve the use of
purchase orders and contracts for goods and service, so
encumbrance accounting is not needed.
 Timing of Debt service payment mostly due to both political and
financial management consideration, the payment should be
kept consistent. The life of the issue with serial bond is easy but
with term bonds, it takes planning.
 Although each issue of long term or intermediate debt is a
separate obligation, GASB standard suggests a single Debt
service fund be used to service all debts as much as possible if
not as few number of funds as possible.
 For convenience of bondholders, the payment of interest and4the
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 Contd………
6.2.2. General long-term liabilities
 Bond is a written promise to pay a specified principal sum
at a specified future date with interest.
 They are typically issued in 1,000 and 5,000 denominations.
Most long term debt of governmental units consists of one
of the following two basic types of bonds:
[Link] Bond: Term bonds are bonds whose principal is repaid
in lump sum at their maturity date. Such lump sum payments
are usually made possible through accumulation of money in
the Debt service fund on an actuarial basis over the life of the
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 Contd………
2. Serial bonds: These are bonds which have periodic maturities.
The principal of a serial bond are repaid at various or determined
dates over the life of the issue.
 There are four types of serial bonds: Regular serial bond,
Deferred serial bond, Annuity serial bond and Irregular serial
bond.
 In addition to bonds, debit service fund may be required to
service debts arising from:
 Long term debt which arise because of different activities of
governmental unit.
 Debt arising from the use of notes or warranty having a
maturity period of more than a year.
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 cont..

[Link] and uses of cash flows

 Source of finance for Debt service fund:
 Special taxes
 Periodic transfer from General fund
 Investment made for purpose of repaying long term
debt.
 Issuing new bond to refinance a matured bond
 Bond premium and accrued interest on bond sold
 Residual equity transfer from other funds
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 cont..

6.2.4. Illustration on debt service fund

Assume that X town administration issued Br 5,000,000 serial bonds
on Jan 1, 2007 for the construction of recreational park. The bond
bear semi- annual interest rate of 5% to be paid on Jan 1 and August
1 and the face value of the bond is to be retired over 10 years by
making equal installment payments on Jan 1 of each year.
Farther, burden of servicing the debt on the tax payers were
distributed evenly throughout the life of bond. Accordingly, it is
determined that tax payers should provide Br 625,000 as revenue in
2007. It is also agreed that the General fund will transfer Br 125,000
to the debt service funds on July, 2007.
Appropriations
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for the year incurred only one semi-annual interest
 cont..

The entry to record the legally adopted budget is as follows:

Estimated revenue …………………………………………. 625,000
Estimated other financing source ……………………125,000
Appropriations (5%X5000, 000)………….250, 000
Fund Balance ……………………………………...500,000
2. During the year 2007, the debt service fund levied property tax of
Br 650,000 of which 3.85% is estimated to be uncollectible. The entry
would be :
Property tax- receivable current ………………… 650,000
Allowance uncollectible 3.85%(650,000)
………… 25,000
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 cont..

If cash in the amount of Br 567,000 is realized from the property tax

during the current year, the entry in the debt service fund should be :
3. Cash ……………………………………………575,000
Property tax receivable
current……………………….575,000
If Br 1,250 of uncollectible taxes are write-off, the following entries
should be passed
4. Allowance for uncollectible property tax ……………………1,250
Property tax receivable current ………………………………
1,250
To generate asset, in addition to those contributed by the tax payers
and the General fund, the tax receipts are invested in marketable
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 cont..

When some of the investments are sold for Br. 250,000 of which Br. 25,000
is interest earned on investments, the following entry should be made:
6. Cash…………………….. …………250,000
Investment ……………………………………… 225,000
Revenue (interest on investment)…………………. 25,000
For investments due to the town bond holders, checks are issued in August
after vouched for the amount of the semiannual interest. The entries to
record the due is as follows:
7. Expenditure- interest ………………………… 250,000
Interest payable……………………………………………250,000
To record the payment of the expenditure
8. Interest payable………………………………… 250,000
Cash……………………………………………….250, 000
To record the issuance of checks for payment of the transfer of Br. 125,000
from the General fund, classified as an operating transfer in and recorded
to the Debt service fund book as follows:
9. Cash …….……………………. 125,000
Operating Transfer In ………………………125,000
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 cont..

On Dec 31, 2007, the balance sheet date of the interest earned but not
yet received on the investment amounted to Br. 12,500. This transaction
should be recorded as:
10. Interest receivable on investment……………… 12,500
Revenue-interest earned on investment……………….
12,500
If the remaining Br. 275,000 of the marketable securities previously
acquired and still held on Dec 31, 2007 had market value of Birr
287,500, the following journal entries should be passed to record the
increase in value.
11. Investments………………….. …12,500
Revenue from increase in fair market value of investment...
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 X Town Administration
Debt Service Fund
Pre- closing Trial Balance
As of Dec 31, 2007
Debit Credit
•Cash……………………………………… Br. 200,000
•Property tax receivable current …………. 73,750
•Allowance for uncollectible tax……………………………… Br.23,750
•Investments ………………………………. 287,500
•Interest receivable………………………… 12,500
•Revenue property tax …………………………………………… 625,000
•Revenue interest earned…………………………………………. 37,500
•Revenue from increase in mkt value of security --------------------- 12,500
•Operating transfer in ……………………………………………. 125,000
•Expenditure (interest)……………………… 250,000
•Estimated revenue………………………… 625,000
•Estimated other financial source…………… 125,000
•Appropriations……………………………………………………. 250,000
•Fund 12/26/2024
balance……………………………………………………… 500,000 13
The statement of revenue, expenditure & change in fund balance and Balance sheet for X town can be prepared from the
forgoing transaction as follows:
X Town Administration
Debt Service Fund
Statement of Revenues Expenditures and Change in Fund Balance
For the year Ended Dec 31, 2007
•Revenues :
•Property tax ………………………………….. Br.625,000
•Interest on investment ……………………….. 37,500
•Increase in fair mkt value of invest…………... 12,500 ………… Br.675, 000
•Expenditures :
•Semi annual interest ………………………….. …………………… (250,000)
•Excess of revenue over expenditure…………………………………… 425,000
•Add: Other financing sources:
•Operating transfer in ……………………………. 125,000
•Less: Other financing uses ……………………….. 0……………………125,000
•Excess of revenue and other financing sources
•Over expenditure and other financing uses…………………………………550,000
•Add beginning fund balance……………………………………………… 0
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•Ending fund balance……………………………………………………Br.550,000
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