In accounting for regular serial bond debt service funds various issues come into play. The regular serial bond debt is usually self-amortizing, thus there is no need to create a sinking fund. They also mature in annual installments (Henderson, Peirson and Herbohn, 2008, p. 236). Amortization is the process of allocating cost to product or expenditure of bonds over the useful life. The bond premium will normally be amortized using the straight-line to allocate costs.
Amortization depends largely on the choice of the accounting method, the life of the asset and the salvage value assumptions to be made by the entity owning the asset to be depreciated. This is also affected by the accounting convention used or the accounting standards adopted by the government unit.
Accounting for deferred serial bond debt service funds
This is accounted for using a modified accrual accounting basis at a market value where a sinking fund is created. This is because they mature as a lump-sum amount at end of its life. The tax is usually accounted for since the debt service fund is levied although it is rarely used. The fund in sinking fund is usually restricted amount and considered long term investment (Engstrom and Copley, 2004 p. 129).
One restrictive provision that is normally included in a bond indenture is a sinking fund requirement. The objective of this requirement is to provide for the systematic retirement of the outstanding bonds before maturity. Bondholders generally favor this activity since it reduces the firm’s debt and thereby its financial riskiness as the bond approaches to simplify the sinking fund retirement of bonds, a call feature is normally included in the indenture. This feature permits the issuer to repurchase outstanding bonds at a specified price. The firm may be required to make fixed or variable sinking fund payments. Fixed payments represent pre-specified annual dollar repurchases; variable payments require the firm to repurchase an amount of bonds equal to a certain percentages of earnings. Since the variable plan requires that few or no bonds be repurchased in a lean year, bondholders prefer fixed sinking fund requirements. Even the fixed payment plans often provide for a balloon payment in order to retire outstanding bonds at maturity. Most issues require fixed dollar sinking fund payments (Larkin and DiTommaso, 2005, p. 78).
Under sinking fund requirement, the issuer can either purchase the bonds in the market place or call them at the specified call price. It will call bonds only when sufficient bonds cannot be purchased directly in the market place or when the market price of the bond is above the call price (Wilson and Kettelus 2003, p. 225)
Journal entries
- The cash received will be recorded in the capital project fund account as proceeds of bonds and debt service fund for the premium. It will be recorded in the government activities as bonds payable and in premium on bond payable.
- The liability of $ 10,000,000 will be recorded in capital project fund as other financing and in the government activities as bonds payable.
- The cost of the project will be recorded in the capital project fund.
- The bond interest will be recorded in the debt service fund.
- Amortization of bond will be recorded in the government activities.
Restricted assets may serve over time as a useful indicator of financial position of an entity. The governmental unit uses these restricted assets to provide services to citizens; consequently, these assets are not available for future spending. Although they is reported net of related debt, it should be noted that the resources needed to repay this debt must be provided from other sources, since the capital assets themselves cannot be used to liquidate these liabilities. Restricted assets represent resources that are subject to restrictions on how they can be used. The remaining balance of unrestricted assets may be used to meet the government’s unit ongoing obligations to citizens and creditors (Godfrey, Hodgson, Holmes and Tarca, 2006, p. 87).
The activities to be included in these activities, liabilities and fund equity arising form assets should be recognized in this statement. All expenses written in this statement should relate to decision made by organization management and how it resources are used. Revenues should also be included to include all inflows. Cash flows should include those from operating activities, non capital financing activities, capital and related financing activities and investing activities (Granof, 2001, p. 125).
Financial accounting standards board have issued statement number 117 and 116 which are relating to reporting on non profit organization. Statement number 117 requires non-profit organizations to statement of financial position, statement of activities and a statement of cash flows as primary statements for reporting all their activities. It states that, the statement of financial position should show her assets as unrestricted net assets, temporary restricted net assets and permanently restricted assets.
Reference List
Engstrom, J.H. & Copley P.A. (2004). Essentials of Accounting for Governmental and Not-for-Profit Organizations. New York: McGraw-Hill/Irwin
Godfrey, J., Hodgson A., Holmes S. & Tarca A. (2006). Accounting Theory. New York: John Wiley and Sons.
Granof, M.H. (2001). Government and not-for-profit accounting – concepts and practices. New York: John Wiley & Sons
Henderson, S., Peirson G. & Herbohn K. (2008). Issues in Financial Accounting. French’s Forest: Pearson Education Australia
Larkin, R.F. & DiTommaso M. (2005). Wiley Not-for-Profit GAAP 2005 – Interpretations and Application of Generally Accepted Accounting Principles for Not-for-Profit Organizations. Hoboken, New Jersey: John Wiley & Sons.
Wilson E.R. & Kettelus S.C. (2003). Accounting for Governmental and Nonprofit Entities. New York: McGraw-Hill