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[img width="13" height="13" src="file:///C:/Users/Doldron/Desktop/PicExportError" alt="*">Problems 6-4, 6-6, 6-7, 6-9, and 6-10
[img width="13" height="13" src="file:///C:/Users/Doldron/Desktop/PicExportError" alt="*">Problems 7-4, 7-5, 7-7, 7-9, and 7-10
6-4
The accounting for bond premiums is not the mirror
image of that for bond discounts.
Pacific Independent School District issued
$100 million of general obligation bonds to finance
the construction of new schools. The bonds were
issued at a premium of $600,000.
1. Prepare the capital projects fund journal
entries to record the issue of the bonds and
the transfer of the premium to an appropriate
fund.
2. Suppose, instead, that the bonds are issued at a
discount of $600,000 but that the project still
costs $100 million. Prepare the appropriate
entries.
a. Contrast the entries in this part and in
part 1.
b. Indicate the options available to the school
district and tell how they affect the entries
required of the district.
c. Suppose the government chose to finance
the balance of the project with general
revenues. Prepare the appropriate capital
projects fund entry.
6-6
The construction and financing phase of a special assess-
ment project is accounted for in a capital projects fund;
the debt service phase is accounted for in a debt service
fund (see the next problem).
Upon annexing a recently developed sub-
division, a government undertakes to extend
sewer lines to the area. Estimated cost is $1 0
million. The project is to be funded with
$8.5 million in special assessment bonds and a
$1 .0 million reimbursement grant from the state.
The balance is to be paid by the government out
of its general fund. Property owners are to be
assessed an amount sufficient to pay both prin-
cipal and interest on the debt. The government
estimated that, during the first year of the proj-
ect, it would earn $200,000 in interest on the
temporary investment of bond proceeds, an
amount that would reduce the required transfer
from the general fund. It also estimated that
bond issue costs would be $1 80,000.
During the year, the government engaged in
the following transactions, all of which should be
recorded in a capital projects fund.
a. It issued $8.5 million in bonds at a premium of
$300,000 and incurred $180,000 in issue costs.
The premium, net of issue costs, is to be trans-
ferred to a newly established debt service fund.
b. It received the $1 million grant from the state,
recognizing it as deferred revenue until it
incurred at least $1 million in construction
costs.
c. It invested $7.62 million in short-term (less than
one-year) securities.
d. It issued purchase orders and signed construc-
tion contracts for $9.2 million.
e. It sold $5 million of its investments for $5.14
million, the excess of selling price over cost
representing interest earned. By year-end the
investments still on hand had increased in value
by $60,000, an amount that also could be attrib-
uted to interest earned.
f. It received invoices totaling $5.7 million. As
permitted by its agreement with its prime
contractor, it retained (and recorded as a pay-
able) $400,000, pending satisfactory comple-
tion of the project. It paid the balance of
$5.3 million.
g. It transferred $1 20,000 to the debt service fund.
h. It updated its accounts but did not close them,
inasmuch as the project is not completed and its
budget is for the entire project, not for a single
period.
1. Prepare appropriate journal entries for the
capital projects fund.
2. Prepare a statement of revenues, expenditures,
and changes in fund balance, in which you
compare actual and budgeted amounts.
3. Prepare a year-end balance sheet.
4. Does your balance sheet report the construc-
tion in process? If not, where might the con-
struction in process be recorded?
6-7
Thedebtservicephasespecialassessmentbondsareaccounted
for in a debt service fund (see the previous problem).
As indicated in the previous problem, a gov-
ernment issued $8.5 million of special assessment
bonds to finance a sewer-extension project. To
service the debt, it assessed property owners $8.5
million. Their obligations are payable over a period
of five years, with annual installments due on
March 31 of each year. Interest at an annual rate
of8% is to be paid on the total balance outstanding
as of that date.
The bonds require an annual principal pay-
ment of $1.5 million each year for five years, which
is due on December 31. In addition, interest on the
unpaid balance is payable twice each year, on June
30 and December 31, at an annual rate of 8%.
The government agreed to make up from its
general fund the difference between required debt
service payments and revenues.
At the start of the year, the government estab-
lished a debt service fund. It estimated that it would
collect from property owners $1.3 million in spe-
cial assessments and $500,000 of interest on the
unpaid balance of the assessments. In addition, it
expected to earn interest of $80,000 on temporary
investments. It would be required to pay interest of
$680,000 and make principal payments of $1.7
million on the outstanding debt. It anticipated
transferring $500,000 from the general fund to
cover the revenue shortage.
During the year, the government engaged in
the following transactions, all of which affect the
debt service fund.
a. It recorded the $8.5 million of assessments
receivable, estimating that $200,000 would be
uncollectible.
b. The special assessments bonds were issued at a
premium (net of issue costs) of $120,000. The
government recognized the anticipated transfer
of the premium to the debt service fund.
c. During the year, the government collected $2.0
million in assessments and $400,000 in interest
(with a few property owners paying their entire assessment in the first year). During the first 60
days of the following year, it collected an addi-
tional $100,000 in assessments and $10,000 in
interest, which were due the previous year.
d. It transferred $120,000 (the premium) from the
capital projects fund.
e. It purchased $800,000 of six-month Treasury
bills as a temporary investment.
f. It made its first interest payment of $340,000.
g. It sold the investments for $850,000, the differ-
ence between selling price and cost representing
interest earned.
h. It recognized its year-end obligation for interest
of $340,000 and principal of $1.7 million but
did not actually make the required payments.
i. It prepared year-end closing entries.
1. Prepare appropriate journal entries for the
debt service fund.
2. Prepare a statement of revenues, expenditures,
and changes in fund balance in which you
compare actual and budgeted amounts.
3. Prepare a year-end balance sheet.
4. Does your balance sheet report the balance of
the bonds payable? If not, where might it be
recorded?
6-9
Governments may report substantially different
amounts of interest on their government-wide and
fund financial statements.
Charter City issued $100 million of 6%,
20-year general obligation bonds on January 1,
2012. The bonds were sold to yield 6.2% and hence
were issued at a discount of $2.27 million (i.e., at a
price of $97.73 million). Interest on the bonds is
payable on July 1 and January 1 of each year.
On July 1, 2012, and January 1, 201 3, the city
made its required interest payments of $3 million
each.
1. How much interest expenditure should the
city report in its debt service fund statement
for its fiscal year ending December 31, 2012?
During 2012 the city did not transfer resources
to the debt service fund for the interest pay-
ment that was due January 1, 2013.
2. How much interest expense should the city
report on its government-wide statements for
the year ending December 31, 2012? (It might
be helpful to prepare appropriate journal
entries.)
3. On January 1, 2032 the city repaid the bonds.
How should the repayment be reflected on the
city’s (1) fund statements and (2) government-
wide statements?
6-10
Debtors may be able to realize an economic gain by
defeasing their debt ‘‘in substance.’’
A hospital has outstanding $100 million of
bonds that mature in 20 years (40 periods). The
debt was issued at par and pays interest at a rate of
6% (3% per period). Prevailing rates on compara-
ble bonds are now 4% (2% per period).
1. What would you expect to be the market price
of the bonds, assuming that they are freely traded? Is there an economic benefit for the
hospital to refund the existing debt by acquir-
ing it at the market price and replacing it with
new, ‘‘low-cost’’ debt? (Present value at 2% of
$1 paid at the end of 40 periods ¼ $.452890;
present value at 2% of an annuity of $1 paid at
the end of each of 40 periods ¼ $27.3 5548)
2. Assume the bonds contain a provision per-
mitting the hospital to call the bonds in
another five years (1 0 periods) at a price of
$1 05 and that any invested funds could earn a
return equal to the prevailing interest rate of
4% (2% per period). What is the economic
saving that the hospital could achieve by
defeasing the bonds ‘‘in substance’’? (Pres-
ent value at 2 % of $1 paid at the end of
1 0 periods ¼ $.82 03 48; present value at 2 %
of an annuity of $1 paid at the end of each of
1 0 periods ¼ $8.98258)
7-4
Capital assets are accounted for in government-wide
statements on a full accrual basis.
The following summarizes the history of
Sharp Hall, the main foreign language classroom
building at a state university that bases its account-
ing on the reporting model applicable to cities and
other general purpose governments.
a. In 1985 the university constructed the building
at a cost of $1,500,000. Of this amount,
$1 ,000,000 was financed with bonds and the
balance from unrestricted university funds.
b. In the 10 years from 1985 through 1995, the
university recorded depreciation (as appropri-
ate) based on an estimated useful life of30 years.
c. In the same period, the university repaid
$750,000 of the bonds.
d. In 1996 the university renovated the building at
a cost of $3,000,000. The entire amount was
financed with unrestricted university funds. The
renovation was expected to extend the useful life
of the building so that it would last a total of 25
more years—that is, until 2021.
e. In the 15 years from 1996 through 2011, the
university recorded depreciation (as appro-
priate). Depreciation was calculated by dividing
the undepreciated balance of the original cost,
plus the costs of renovation, by the anticipated
remaining life of 25 years.
f. In the same period, the university repaid the
$250,000 balance of the debt.
g. In 2012 the university demolished the building
so that the land on which it was situated could be converted into a practice field for the wom-
en’s soccer team.
Prepare the journal entries to summarize the
history of the building, as reported in the univer-
sity’s government-wide statements.
7-5
Capital assets are accounted for in governmental fund
statements on a modified accrual basis.
Refer to the transactions in the previous
problem.
1. Prepare journal entries for the university to
make in its governmental funds (e.g., its gen-
eral fund or a capital projects fund).
2. How would you recommend that the univer-
sity maintain accounting control over the cap-
ital assets themselves—those that you did not
record as assets in the governmental funds?
7-7
If governments do not preserve their infrastructure
assets, they must depreciate them.
1. In 2012 Bantham County incurred $80 million
in costs to construct a new highway. Engineers
estimate that the useful life of the highway is
20 years. Prepare the entry that the county
should make to record annual depreciation
(straight-line method) to facilitate preparation
of its government-wide statements.
2. What reservations might you have as to the
engineers’ estimate of useful life? Why might
any estimate of a highway’s useful life be
suspect?
7-9
Similar collectibles may be accounted for quite differently.
The City of Allentown recently received a
donation of two items:
A letter written in 1820 by James Allen, the
town’s founder, in which he sets forth his plan
for the town’s development. Independent
appraisers have valued the letter at $24,000.
A 1920 painting of the town’s city hall. Compa-
rable paintings by the same artist have recently
been sold for $4,000.
The city intends to place the letter on public
display in its city hall. It plans to sell the painting
and use the proceeds to redecorate the city coun-
cil’s meeting chambers. The town’s policy is to
capitalize collectibles only when required by GASB
standards to do so.
1. Prepare journal entries, as necessary, to reflect
how each of the contributions should be
reported on the city’s government-wide finan-
cial statements. Briefly explain and justify any
apparent inconsistencies in the entries.
2. Suppose that the city had purchased each of
the items. Would that affect whether or not
you capitalized each of the assets?
3. Suppose that when the city accepted the painting,
itagreed, ifitsold the painting, to use the proceeds
onlyto acquire other works ofart. Does that affect
how you account for the painting?
4. Suppose that the city operates a museum. The
museum’s building, furniture, and fixtures
cost $10 million and, on average, are midway
through their useful life. They have a replace-
ment cost of $12 million. The art collection
has a market value of $3 00 million. Consistent
with your response to part a, what value would
you place on the art collection? What value
would you place on the building, furniture,
and fixtures? Briefly justify your response,
commenting specifically on whether you think
the resultant statement of net assets would
provide useful information to statement users.
7-10
Investment notes enable the reader to assess both credit
and interest rate risks.
A note from the annual report of a city in-
cludes the following:
As of September 30, the utility fund had the
following investments:
Fair
Value
(in thousands) Weighted-
Average
Maturity
(days)
Local government
investment pool $ 6 1
U.S. Treasuries 27,600 790
U.S. Agencies 80,400 520
Total $108,006 589
Credit risk. As of September 30, the U.S.
Treasuries and the U.S. agency bonds were
rated AAA by Standard & Poor’s. The local
government investment pool was rated AA.
Interest rate risk. As a means of minimizing
risk of loss that is due to interest rate fluctua-
tions, the investment policy requires that the
dollar-weighted average maturity, using final
stated maturity dates, not exceed seven years.
The portfolio’s weighted-average maturity,
however, may be substantially shorter if mar-
ket conditions so dictate. As of September 30,
the dollar-weighted average maturity was 589
days (1.61 years).
1. Why does the city limit the weighted-average
maturity of its portfolio to seven years rather
than a greater number of years, even though
investments with a longer maturity generally
provide a greater investment yield?
2. Why might the city indicate that the average
maturity of the local government investment pool is only one day even if, in fact, the pool
holds investments that have an average matu-
rity of over 3 0 days?
3. What is meant by credit risk? How do you
assess the credit risk of the U.S. Treasury and
U.S. agency bonds? Explain.
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