1.

Chapter Outline
1. What are Capital Projects and Debts Services?
2. Bond Proceeds and Issue Costs
3. Debts Service Funds
4. Interest on Long Term Debts
5. Debts Refundings
2. What are Capital Projects and Debts
Services?
Capital Projects– refers to government acquisition and/or establishment of
capital facilities or structures such as roads, bridges, airports, sewerage system,
hydro electricity dams, plant and equipment, vehicles etc

Debts Service – Refers to the interest payments are made in respect of long term
bonds or loans including principal received from lenders to finance the acquisition
of the capital expenditure.

How does Government finance its Capital Projects?

1. Issue of bonds – Government issues convertible notes in return for cash to
finance a project.
2. Long term debt – Government obtains long term loan (Controversial UBS
loan) to finance a project.
3. Tax Credit Scheme – A projects gets completed by an investor on a tax
credit scheme (i.e road constructed by Oil Search in Tari/ Tari Hospital
Project) Government
4. Grant Aid – Government sets aside funds from its annual budget to
complete certain infrastructure projects…(DSIP/PSIP funds for MPs)
3. Bonds Proceeds and Issue Costs
 Capital project funds do not report on term obligations. Therefore when the
proceeds of bonds are received, they are recognized as Other Financing
Source ( Income).

 Issue Costs – The bond underwrites (brokers and dealers) will withhold a
portion of the gross proceeds as fees for their services. These fees are called
issue costs.

 Coupon rate – The bond coupon rate (stated interest rate) is the rate when
the bond is printed. It may not be equal to the rate at the time when the note
is issued.

 Market rate (yield rate) - The rate at the time when the bond is issued.

 Discount – A bond sold where the prevailing market rate is greater then
coupon rate at the time of issue. The bond is of LESS value then face value.

 Premium - A bond sold where the prevailing market rate is less then the
coupon rate. The bond is of greater value then the market face value on issue.
3.1 Bond Issued at Premium
 Example 1:
A Government plans to build a highway road construction project which will
cost the government approximately $50 million. To finance the project the
Government issue government bonds with a face value of $50 million. The
bonds were issued at a coupon rate of 6% to mature in 30 years. Interest were to be
paid semi-annually. The prevailing market rate of bonds were set at 5.9%.

- Note that the coupon rate (6%) is more than market rate of (5.9%). i.e The bond
value was $1,000,000 more than the market price. Therefore, it’s said to be issued at
a premium. The bond notes were issued for $50.699 million including broker fees.
Journal
Dr Cr
Cash $50.699 mill
Other financing sources – bond proceeds $50mill
Debts Service Funds – (Bond premium) .699 mill
To record issue of bond proceeds.
* Note that Debts Service Funds is the fund ledger that is used to record all
debts service payments entries.
3.2 Bond Issued at Discount
 Example 2:
The Government plans to build a subway overhead bridge project in the city
metropolis which will cost the government approximately $50 million. To finance
the project the Government issue government bonds with a face value of $50
million. The bonds were issued at a coupon rate of 6% to mature in 30 years.
interest were to be paid semi-annually. The prevailing market rate of bonds were
set at 6.1%.

- Note that the coupon rate (6%) is less than market rate of (6.1%). i.e The bond
value was $1,000,000 less than the market price. Therefore, it’s said to be issued
at a discount. The bond notes were issued for $49.315 million including broker
fees.
 Journal
Dr Cr
Cash $49.315 mill
Bond discount $.685 mill
Other financing sources – bond proceeds
$50 mill
To record issue of bond proceeds.

*Note that the cash received is brought into the books and accounted for as
from other revenue source. The liability component in not recognized
until the first installment is due.
4. Debt Service Funds
 What is debt servicing?
Are funds maintained to account for resources (funds) accumulated to pay
interest and principal on generally long term debt associated with government
activities.

Sources of Debt Service funds:

1. Transfer from General fund
2. Special Taxes
3. Special Assessments

• Debts Service funds are accounted for using the Modified Accrual Basis of
Accounting.
• Unlike the general rule of accounting for expenditure accrual, unmatured
principal and interest on general long term debt are NOT considered current
liabilities of the debts service fund.
5. Interest on Long Term Debt
What is interest? It is a major government expenditure for loan
servicing comprising of interest and principal.
What are the accounting issues?
Because government funds do not record long term liabilities, when a loan is
established, the increase in cash is recognized as an asset and the debt (liability)
is recognized as bond proceeds (other financing source- income).

1) Establishment of loan;
Journal: DR Cr
Cash xxx
Bonds proceeds xxx
To record funds received on loan funds for road construction.

GASB – Interest and Principal on long-term debt should not be accrued in government
funds until the period in which they are due. Until then, they are not current
liabilities, they will not require the liquidation of expendable available resources.
2) Interest Payable due:
When the first loan interest is due and payable, government process the
following entry,
Journal: Dr Cr
Debt service, interest expenditure xxx
Matured interest payable (bonds) xxx
To record interest due on government bonds issued.
3) Loan retirement :
At the expiry of the loan term, the following journal is processed to record the
debt retirement.
Journal: Dr Cr
Debt service - Principal expenditure xxx
Matured bond payable xxx
To record maturity of the government bonds issued.
6. Debts Refundings
 What is debt refundings?
Debts refundings relate to government retiring long term debts
prior to its maturity.
 Reasons for debt refundings earlier than maturity:
1. Due to increased government funds surplus at one time ( i.e
increased price of commodities)
2. Refinance debt financed projects due to free up cash for new projects
or a better deal with lower interest rates .
3. Retirement of debt by selling the financed asset
• Sometime bonds are issued with specific call prices. A call price is a
price upon which the issuer can redeem the bond at the pre-established
price irrespective of the prevailing market price.