Chapter 6: The Governmental Fund Accounting Cycle Capital Projects Funds, Debt Service Funds, and Permanent Funds

Multiple Choice

1. What is the purpose of a Debt Service Fund?a. to account for resources that are restricted or otherwise limited to pay the

debt service on all debt of the government, including Enterprise fund debt and short-term debt used to finance General Fund operations

b. to account for resources that are restricted or otherwise limited to pay principal and interest on general long-term debt

c. to account for resources that are restricted or otherwise limited to pay the debt service on all long-term debt of the government, and also to show how much long-term debt is outstanding

d. to provide a means of reporting all outstanding long-term debt of the government in a single location

Answer: b

2. At what point should interest be recognized as an expenditure in a Debt Service Fund?a. when it accruesb. when it is paidc. when it is due and payabled. when the bonds resulting in payment of interest are issued

Answer: c

3. A city sells $5 million of 20-year general obligation bonds on October 1, 2013. Interest on the debt is payable at the rate of 5% a year on the unpaid balance of the debt, every six months commencing March 31, 2014. How much should the city report as an interest expenditure in the Debt Service Fund for the calendar year ending December 31, 2013? a. $0b. $30,000c. $60,000d. $120,000

Answer: a

4. A city sells $15 million of general obligation bonds on October 1, 2013. The bonds mature at the rate of $1 million a year each September 30, starting September 30, 2014. The amount due September 30, 2014 is paid. How much should the city report as outstanding debt in the Debt Service Fund in its year-end fund level financial statements on December 31, 2014?a. $15,000,000b. $14,000,000c. $13,750,000d. $0

Answer: d

5. A city sells $5 million of 6% ten-year general obligation bonds on April 1, 2013. The first installment of debt principal ($250,000) is due to be paid on September 30, 2013. What entry should the city make on September 30, 2013 in the Debt Service Fund regarding the bond principal?a. It should recognize a $250,000 liability for Matured bonds payable.b. It should reduce the $5 million long-term liability by $250,000.c. It should do nothing in the Debt Service Fund, but it should reduce Bonds

payable by $500,000 in the Capital Projects Fundd. It should make no entry anywhere until the principal is actually paid.

Answer: a

6. A city keeps its books on a calendar year basis. On April 1, 2013, the city sold $500,000 of 6% general obligation bonds, payable in semi-annual installments. The first installment, due October 31, 2013 covered interest of $15,000 and principal of $25,000. For the year ended December 31, 2013, how much should the Debt Service Fund report as expenditures?a. $15,000b. $40,000c. $15,000, plus an accrual for three months' interestd. $40,000, plus an accrual for three months' interest and principal

Answer: b

7. What kinds of expenditures are accounted for in Debt Service Funds?a. only the principal payments on general obligation long-term debtb. only the interest expenditures on general obligation long-term debtc. both principal payments and interest expenditures on general obligation

long-term debtd. all debt service on all governmental debt, regardless of the purpose of the debt

Answer: c

8. A state issues long-term debt to finance a major construction project. The first installment of debt service requires payment of principal of $75,000 and interest of $100,000. Which of the following statements is true on the day that payment for principal and interest is legally due?a. expenditures of $175,000 should be recognized in the debt service fund.b. expenditures of $75,000 should be recognized in the capital projects fund

and expenditures of $100,000 should be recognized in the debt service fund.

c. expenditures of $100,000 should be recognized in the debt service fund and bonds payable should be reduced by $75,000 in the debt service fund.

d. expenditures of $175,000 should be recognized in the debt service fund and bonds payable should be reduced by $75,000 in the capital projects fund.

Answer: a

9. In what circumstances are Debt Service Funds required to be used in governmental accounting?a. a legal requirement dictates that a Debt Service fund be establishedb. a government is currently accumulating resources for the payment of

principal and interest on long-term debt in future yearsc. a government issues general obligation bondsd. both a and be. both a and c

Answer: d

10. In what circumstance is a Capital Projects Fund required to be used in governmental accounting?a. to record the acquisition or construction of all capital assetsb. to record the acquisition or construction of any capital asset that is not

recorded in an Enterprise Fundc. when capital projects are at least partially financed by general obligation

bond proceedsd. to record the acquisition or construction of all major capital assets, except

infrastructure assets

Answer: c

11. Accrued interest on the following type of debt is reported in a governmental fund:a. short-term tax anticipation notes payableb. serial bondsc. general obligation bondsd. long-term bank notes

Answer: a

12. Which of the following groups of accounts best describes the types of assets and

liabilities likely to be found in Capital Projects Funds?a. cash, investments, construction contract payable, matured bonds payableb. cash, buildings, equipment, construction contracts payablec. cash, investments, construction contracts payable, vouchers payable, long-

term debt payabled. cash, investments, retainage payable, vouchers payable

Answer: d

13. A city accounts for its capital acquisitions using encumbrances. When the city enters into a contract to acquire equipment, what journal entry should it make?a. debit expenditures - capital outlay; credit vouchers payableb. debit encumbrances; credit budgetary fund balance reserved for encumbrancesc. debit equipment; credit vouchers payabled. debit encumbrances; credit appropriations - equipment

Answer: b

14, 15, and 16. The following set of facts applies to questions 14, 15, and 16: A state constructs an office building. The construction is financed with: (1) a transfer of $1 million from the General Fund; (2) a grant of $2 million from the federal government; (3) bond proceeds of $7 million; and (4) earnings of $100,000 from temporary investment of bond proceeds. All transactions occur in one year.

14. Based on the preceding set of facts, how much should be reported as Revenues in the Capital Projects Fund?a. $100,000b. $2,100,000c. $3,100,000d. $8,100,000

Answer: b

15. Based on the preceding set of facts, how much should be reported as Other financing sources in the Capital Projects Fund?a. $1,000,000b. $3,000,000c. $8,000,000d. $10,000,000

Answer: c

16. Based on the preceding set of facts, what should be reported in the financial statements of the General Fund for the year?

a. other financing uses of $1 millionb. expenditures of $1 millionc. other financing sources of $2 million and other financing uses of $1 milliond. revenues of $2 million and other financing sources of $7 million

Answer: a

17. A city issues $5 million of long-term general obligation bonds to construct a new fire house. How and where should that transaction be recorded?a. as an other financing source in the debt service fund b. as a liability in the capital projects fundc. as a liability in the debt service fundd. as an other financing source in the capital projects fund

Answer: d

18. What does the account, retainage payable, represent in the financial statements of a Capital Projects Fund?a. a long-term liabilityb. an amount owed to other governments because capital grant provisions were not metc. an amount held back by a government when paying a contractord. an amount that can be reported in the General Fund, but not a Capital Projects Fund

Answer: c

19. A city acquired two vehicles in a particular year: (1) a sedan for $20,000 that was paid for through the General Fund and (2) a sanitation truck for $125,000 that was paid for through the Capital Projects Fund. How should the assets be reported in the city's fund-level financial statements?a. $145,000 should be reported as assets in the general fundb. $20,000 should be reported as assets in the general fund and $125,000

should be reported as assets in the capital projects fundc. $145,000 should be reported as assets in the capital projects fundd. neither acquisition should be reported as assets in the fund-level financial

statements

Answer: d

20. Which of the following fund types is most likely to have the shortest "life"?a. internal serviceb. capital projectsc. enterprised. special revenue

Answer: b

21. A city constructs a new building by issuing debt in the amount of $3 million. How should the city report the debt proceeds in its Capital Projects Fund statement of revenues, expenditures, and changes in fund balance?

a. as a revenueb. as an other financing sourcec. as a liability captioned general long-term obligationsd. as a liability captioned due to the debt service fund

Answer: b

22. Depending on the restrictions placed on resources used to acquire a police car, the acquisition of the car could be reported in which of the following funds?a. general fundb. special revenue fundc. capital projects fundd. all of the abovee. none of the above

Answer: d

23. How should a fixed asset acquired through a capital lease agreement be recorded in a General Fund?a. at the present value of the future lease payments, by debiting expenditures

and crediting other financing sources - capital leasesb. at the total amount of the future lease payments, by debiting expenditures

and crediting other financing sources - capital leasesc. at the present value of the future lease payments, by debiting expenditures

and crediting capital leases payable.d. no entry is needed until payments are actually made on the capital lease

agreement.

Answer: a

24. A city acquires equipment on January 1, 2013 by means of a capital lease agreement. The agreement calls for paying the leasing company $300,000 in three $100,000 annual payments, starting December 31, 2013. The present value of the three lease payments, using a 6% interest rate, is $267,300. The city will make the lease payments from the General Fund. What journal entry should the city make on January 1, 2013 in the Fund?a. debit expenditures - capital outlay; credit other financing sources, for

$300,000b. debit expenditures - capital outlay; credit other financing sources, for

$267,300c. debit capital assets; credit capital leases payable, for $300,000d. debit expenditures - capital outlay; credit capital leases payable, for

$267,300

Answer: b

25. A Debt Service Fund accumulates resources to retire debt that is due in a lump sum in the year 2014. The Fund held marketable securities that cost $900,000 when purchased during 2006 and 2007. The securities had fair market values of $875,000 on January 1, 2013, and $930,000 on December 31, 2013. The average fair market

value during the year was $895,000. At what amount should the Fund report the securities in its balance sheet on December 31, 2013?a. $875,000b. $895,000c. $900,000d. $930,000

Answer: d

26. The operations of a debt service fund generally are controlled by which of the following mechanisms?a. bond indenturesb. encumbrance accountingc. legislative oversight and reviewd. break-even analysis

Answer: a

27. Capital assets that were financed through governmental fund activities will appear in which financial statement?a. government-wide statement of net assetsb. capital projects fund balance sheetc. debt service fund balance sheetd. enterprise fund balance sheet

Answer: a

28. Retainage payable will most likely appear in which financial statement?a. government-wide statement of net assetsb. capital projects fund balance sheetc. debt service fund balance sheetd. special revenue fund balance sheet

Answer: b

29. The largest dollar amount of resources flowing into a capital projects fund normally will come froma. dedicated property taxesb. user chargesc. bond proceedsd. interest on investments

Answer: c

30. The largest dollar amount of resources flowing into a general obligation debt service fund normally will come froma. tax revenues and interfund transfersb. interest on investments and user chargesc. fiscal agent fees and fines

d. liquidation of encumbrances

Answer: a

31. What type of fund is most likely used to account for the spending of income earned by a Permanent Fund?a. agency fundb. private-purpose trust fundc. enterprise fundd. special revenue fund

Answer: d

32. Which of the following is a characteristic of a Permanent Fund?a. both the corpus of the fund and its earnings must be kept intact permanently.b. permanent funds are created to support programs that benefit other

governmental units.c. earnings of a permanent fund are used to support programs that benefit the

government or its citizens.d. permanent Funds are established when a government receives a bequest

without a legal trust agreement.

Answer: c

33. How should marketable securities be valued when reported in a Permanent Fund’s balance sheet?a. at the cost to the donor of the investmentsb. at the fair value of the investments on the date received by the governmentc. at the fair value of the investments as of the balance sheet dated. at the amount paid to acquire the securities

Answer: c

34. A capital project is completed, but $500,000 remains in a capital projects fund. How should the government use the $500,000 remaining in the capital projects fund?a. the government should retain the remaining funds in the capital projects

fund for a potential future capital projectb. the government should consult provisions of relevant grant and bond

issues, which may provide guidance regarding its usec. the first-in, first out basisd. residual amounts in a capital projects fund after completion of a project

must be transferred to a debt service fund

Answer: b

35. A government may have arbitrage when:a. it finances capital projects through federal grantsb. it borrows money at lower tax-exempt rate, but invests it at a higher ratec. it pays a higher rate on its tax-exempt debt than the rate that it receives

from its investments

d. its debt pays a lower rate of interest than federally issued debt of the same credit quality

Answer: b

Problems

36. (Classification of resource inflows in Fund operating statements)

A county's Debt Service and Capital Projects Funds had the following resource inflows during 2013. State whether each of the inflows should be reported as revenues or as other financing sources in the fund-level statements of revenues, expenditures and changes in fund balances. a. Property taxes levied specifically for the Debt Service Fundb. Cash received from General Fund to finance debt service paymentsc. Cash received from General Fund to finance part of the cost of new police

headquarters d. Grant from state to finance part of cost of new police headquarterse. Proceeds of bonds issued to finance part of the cost of new police

headquarters f. Interest earned on investment of resources being accumulated to finance

constructiong. Increase in fair market value of investments being accumulated to finance

constructionh. Bond premium received by Debt Service Fund from Capital Projects fund

Answer:a. Revenuesb. Other financing sourcesc. Other financing sourcesd. Revenuese. Other financing sourcesf. Revenuesg. Revenuesh. Other financing sources

37. (Basic journal entries for acquisition of capital assets through issuance of debt)

Prepare entries to record the following transactions related to acquisition of capital assets by a county. The county does not use encumbrance accounting. Identify the fund(s) used.

a. The county issues general obligation bonds in the amount of $900,000,

receiving cash for the full face amount of the bonds. The cash will be used to buy capital assets.

b. The county buys a prefabricated building for $750,000, using part of the bond proceeds. The building is delivered and the invoice for the building is approved.

c. The invoice approved in b. is paid.d. The General Fund transfers cash of $55,000 to another fund in anticipation

of the payment of the first installment of interest ($30,000) and principal ($25,000) on the debt.

e. The first installment of debt service on bonds issued in a. becomes due and payable.

f. Debt service on the bonds issued in a. is paid.

Answer:a. CPF

Cash 900,000Other financing source – long-term debt issued 900,000

b. CPFExpenditures - building 750,000

Vouchers payable 750,000

c. CPFVouchers payable 750,000

Cash 750,000

d. GFTransfer out to Debt Service Fund 55,000

Cash 55,000

DSFCash 55,000

Transfer in from General Fund 55,000

e. DSFExpenditures - bond principal 25,000Expenditures - interest 30,000

Matured bonds payable 25,000Matured interest payable 30,000

f. DSFMatured bonds payable 25,000Matured interest payable 30,000

Cash 55,000

38. (Journal entries with emphasis on Capital Projects Fund)

Prepare journal entries in the Capital Projects Fund to record the following

transactions related to the construction of a building by the Village of Navajo Falls. (Note that only Capital Projects Fund journal entries are required.) The Village adopts a formal budget and uses encumbrance accounting.

a. The Village Council adopts a capital budget at the beginning of the year. To finance construction of the building, the Village will transfer $3 million from its General Fund and apply for a state grant of $1 million. It appropriates $4 million for construction.

b. The General Fund transfers $3 million to the Capital Projects Fund for the new project.

c. The state approves Navajo Falls's application for a $1 million construction grant and simultaneously sends a check to the Village. The grant is expenditure driven and thus requires that Navajo Falls incur qualifying expenditures.

d. Navajo Falls awards a construction contract in the amount of $3.4 million.

e. The contractor sends a progress billing to Navajo Falls in the amount of $1.6 million. The bill is approved by the Village's engineers and a voucher is prepared, less a 10% retainage pending completion of the building and final approval by the Village. Navajo Falls considers 25 percent of the billing to be the state's share of the cost.

f. The voucher in e., above, is paid.

g. The contractor encounters construction problems due to unforeseen soil conditions. As a result, Navajo Falls authorizes a change order increasing the cost of the construction contract by $200,000.

h. The contractor completes construction, and sends Navajo Falls an invoice for the remaining $2 million. The Village's engineers inspect the building and accept the work. The invoice is approved and paid, together with the amount retained on the progress billing in e., above. Navajo Falls considers $600,000 of the billing to be the state's share of the cost.

Answer:a. Estimated other financing sources 3,000,000

Estimated revenues 1,000,000Appropriations 4,000,000

b. Cash 3,000,000Transfer in from General Fund 3,000,000

c. Cash 1,000,000Advance on construction grant 1,000,000

d. Encumbrances 3,400,000Budgetary fund balance reserved for encumbrances 3,400,000

e. Budgetary fund balance reserved for encumbrances 1,600,000Encumbrances 1,600,000

Expenditures - construction costs 1,600,000Construction contracts payable 1,440,000Retainage payable 160,000

Advance on construction grant 400,000Revenues - construction grant 400,000

f. Construction contracts payable 1,440,000Cash 1,440,000

g. Encumbrances 200,000Budgetary fund balance reserved for encumbrances 200,000

h. Budgetary fund balance reserved for encumbrances 2,000,000Encumbrances 2,000,000

Expenditures - construction costs 2,000,000Construction contracts payable 2,000,000

Construction contracts payable 2,000,000Retainage payable 160,000

Cash 2,160,000

Advance on construction grant 600,000Revenues - construction grant 600,000

39. (Journal entries with emphasis on Debt Service Fund)

The Shannon Township Debt Service Fund accumulates resources to pay its $2 million general obligation debt. The debt is payable in equal annual installments of principal over 10 years with 5% interest on the unpaid principal. Prepare journal entries to record the following transactions in the Debt Service Fund.

a. The Township levies a special property tax amounting to $500,000 to pay debt service on its long-term general obligation debt. The tax must be accounted for in the Debt Service Fund.

b. All the property taxes levied for debt service purposes are collected.c. The Township invests $150,000 in a six-month certificate of deposit.d. Debt service (interest of $100,000 and principal of $200,000) becomes due

and payable.e. The debt service liabilities are paid.f. The certificate of deposit in c. matures and the Township receives a total of

$153,000, which includes $3,000 of interest.

Answer:a. Property taxes receivable 500,000

Revenues - property taxes 500,000

b. Cash 500,000Property taxes receivable 500,000

c. Investments 150,000Cash 150,000

d. Expenditures - bond principal 200,000Expenditures - interest 100,000

Matured bond principal payable 200,000Matured bond interest payable 100,000

e. Matured bond interest payable 200,000Matured bond interest payable 100,000

Cash 300,000

f. Cash 153,000Investments 150,000Revenues – interest earned on investments 3,000

40. (Journal entries to record a capital lease transaction)

A town enters into a lease-purchase agreement with Trucks, Inc. to acquire four garbage trucks. The agreement provides that the town pay $100,000 at the end of each year for four years. Upon full payment, the trucks become town property. The agreement is based on an interest rate of 7%. (The present value of an annuity of $1 for 4 periods at 7% is 3.3872.) The lease agreement is accounted for in the General Fund.

Required:Prepare journal entries for the General Fund to record (a) the lease agreement and

the lease payment (b) at the end of the first year and (c) at the end of the second year.

Answer:(a) Record lease agreementExpenditures - capital outlay 338,720

Other financing sources - capital leases 338,720

(b) Lease payment at end of first yearExpenditures - capital lease principal 76,289Expenditures - capital lease interest 23,711

Cash 100,000

(c) Lease payment at end of second yearExpenditures - capital lease principal 81,630Expenditures - capital lease interest 18,370

Cash 100,000

Note - The present value of the lease is $100,000 x 3.3872 or $338,720. Interest for the first year is $338,720 x .07 = $23,711; and payment on principal is the difference between the $100,000 cash payment and the interest of $23,711. After the payment, the "outstanding debt" is the difference between the original debt of $338,720 and payment of $76,289, or $262,431. Therefore, the second year's interest is $262,431 x .07= $18,370, and the payment on principal is $81,630. (This problem could be varied by asking the student to prepare a schedule showing the principal and interest payments for the life of the lease.)

41. (Journal entries for a major construction project)

Prepare journal entries to record the following transactions of a state, identifying the funds affected by each transaction. Record journal entries for all funds affected. The state prepares a budget for the Capital Projects Fund and uses encumbrance accounting in that fund.

a. The state records its capital budget. It appropriates $10 million for highway construction, which will be financed entirely with the issuance of bonds.

b. The state sells 20-year 6% bonds having a face value of $10 million. The bonds are sold at a discount, so the state realizes a total of $9,900,000. Equal installments of principal will be paid every six months, together with interest on the unpaid balance.

c. The state awards two contracts, one for highway construction ($6,500,000) and one for construction supervision ($350,000). Both contracts provide for progress payments. The highway construction contract provides for 10% retainage pending completion of the project. There is no retainage on the construction supervision contract.

d. The construction contractor submits an invoice for $1,500,000. The invoice is approved and a voucher is prepared, less the 10% retainage.

e. The construction supervisor submits an invoice for $100,000, and a voucher is prepared.

f. Both of the invoices in transactions d. and e. are paid.g. The state transfers $800,000 from the General Fund to the Debt Service

Fund in anticipation of the payment of debt service on the bonds.

h. The first semi-annual debt service on the 20-year bonds becomes due and payable (see transaction b).

i. The debt service is paid.

Answer:a. CPF

Estimated other financing sources 10,000,000Appropriations 10,000,000

b. CPFCash 9,900,000Other financing use – bond issue discount 100,000

Other financing source - long-term debt issued 10,000,000

c. CPFEncumbrances – capital project 6,850,000

Budgetary fund balance reserved for encumbrances 6,850,000

d. CPFBudgetary fund balance reserved for encumbrances 1,500,000

Encumbrances – capital project 1,500,000

Expenditures - construction costs 1,500,000Construction contracts payable 1,350,000Retainage payable 150,000

e. CPFBudgetary fund balance reserved for encumbrances 100,000

Encumbrances - capital project 100,000

Expenditures - construction supervision 100,000Vouchers payable 100,000

f. CPFConstruction contracts payable 1,350,000Vouchers payable 100,000

Cash 1,450,000

g. GFTransfer out to Debt Service Fund 800,000

Cash 800,000

DSFCash 800,000

Transfer in from General Fund 800,000

h. DSFExpenditures - bond principal 250,000Expenditures - interest 300,000

Matured bonds payable 250,000Matured interest payable 300,000

i. DSFMatured bonds payable 250,000Matured interest payable 300,000

Cash 550,000

42. (Preparing entries to close a Capital Projects Fund) [see p. 195… uses “close” not “abolish”]

You are the Finance Director of the Town of Blue Mountain. Presented below is the trial balance for a Capital Projects Fund of the Town at October 31, 2013. The Town Engineer has advised you that the project accounted for within this fund, a new system of bicycle trails, is complete and formal acceptance by the Town is pending. The Town Council has directed you to abolish this fund and transfer any remaining net assets to the Town’s Debt Service Fund. Prepare the entries necessary to settle the remaining liabilities of the fund, close the accounts, and transfer the remaining net assets to the Debt Service Fund..

Town of Blue MountainCapital Projects Fund

Preclosing Trial BalanceOctober 31, 2013

Debits Credits

Cash $ 70,160

Vouchers payable $ 24,450

Retainage percentage 42,750

Restricted fund balance 117,285

Revenues - interest 50,175

Expenditures - capital outlay 197,000

Transfer in from General Fund 32,500

$ 267,160 $ 267,160Answer:

Vouchers payable 24,450Retainage payable 42,750

Cash 67,200

Revenues - interest 50,175Transfer in from General Fund 32,500Restricted fund balance 114,325

Expenditures - capital outlay 197,000

Transfer out to Debt Service Fund 2,960Cash 2,960

Restricted fund balance 2,960Transfer out to Debt Service Fund 2,960