Debt service funds are used to account for the accumulation of resources to pay principal and interest on long-term debt. Resources come from tax revenues, transfers from other funds, and interest earnings. The debt service fund is used to record the receipt of these resources and the payment of principal and interest. Journal entries are made for items such as receiving transfers, earning interest revenue, recording expenditures for interest payments, and paying principal and interest. The modified accrual basis is used, so interest expenditure is only recorded when due rather than accrued over time.

1. Debt Service Funds
 A debt service fund is a cash reserve that is used to pay for the interest and
principal payments on certain types of debt.
 The existence of a debt service fund is intended to reduce the risk of debt
security for investors, which makes it more attractive to them and also
reduces the effective interest rate needed to sell the offering.
 Governments often issue long-term debt to finance various governmental
projects.
 Generally, this long-term debt is repaid from a governmental fund called a
debt service fund.
 In some cases, although not legally required, a government may choose to
establish a debt service fund to account for the accumulation of resources
that will be used for debt service.

2. Debt Service Funds record the accumulation of resources and payment of
principal and interest on general long-term obligations and payments on
certain leases/purchases or other contractual obligations. Debt service
payments are generally tax-supported via operating transfers from
the General Fund.
Example: If you have a Tk.100,000 loan at 6% interest for 10 years, debt
service might be measured by 12 monthly payments of Tk.1,110.21

3. Purpose of a debt service fund
A debt service fund exists
 to record and manage payments of principal and interest related to
general long-term liabilities,
 to record and manage revenues restricted for debt repayment and
other funds, such as inter-fund transfers, that will be used for those
payments.

4. Importance of Debt Servicing
 Debt service refers to the cash required to pay back interest and
principal on debt obligations. A company may be required to hold a
debt service reserve account (DSRA) to reassure lenders.
 Debt servicing is important to maintain a good credit score for future
borrowing.
 The debt service coverage ratio (DSCR) is a measure of a company’s
ability to make debt payments on time

5. Sources of Debt Service Fund
 Interest Revenue
 Earmarked Taxes
 Special Assessments
 Transfers From General Fund
 Transfers From Other Funds
 Residual Transfers

6. Journal Entry (Common Transactions)
A. Receipt Transfer From Another Fund:
Cash
Interfund Transfer In
B. Revenue Earned:
Cash / Receivable
Revenue

7. C. Legally Due:
Expenditure -Interest
Interest Payable
D. Payment of Interest & Payment of Interest & Principal:
Expenditure - Interest
Expenditure – Principal
Cash

8. E. Equity Transfer from Another Fund:
Cash
Interfund Transfer- In

9. Types of Debt Service Funds
A. Serial Bond: A serial bond is a bond issue that is structured so that a
portion of the outstanding bonds mature at regular intervals until all
of the bonds have matured. Because the bonds mature gradually over
a period of years, these bonds are used to finance projects that
provide a consistent income stream for bond repayment. The entire
bond issue is sold to the public on the same date, and the maturity
dates are stated in the offering documents.
Example: For example, a Tk.1,000,000, the ten-year serial bond will
have Tk. 100,000 bonds mature once a year for ten years.

10.  Regular Serial Bond: Total principal of an issue is repayable in a
specified number of equal annual installments over the life of the
issue.
 Deferred Serial Bond: The first installment is delayed for a period of
more than one year after the date of the issue but subsequent
installments fall due on a regular basis.
 Annuity Serial Bond: The amount of annual principal repayments are
scheduled to increase each year by approx. the same amount that
interest payments decrease so that the total debt service remains
reasonably level over the term of the issue.
 Irregular Serial Bond. Any pattern of repayment that does not fit other
categories.

11. B. Term Bond: A term bond refers to a bond that matures on a single,
specific date in the future. At the time, the bond’s face value (i.e., the
principal amount) must be repaid to the bondholder. The term of the
bond is the amount of time between the bond's issuance and its maturity.

12. Debt Service Coverage Ratio (DSCR)
A business needs to compute its debt service coverage ratio (DSCR)
before it begins borrowing. The DSCR is critical to measuring the
company’s ability to make debt payments on time. The ratio divides the
company’s net income with the total amount of interest and principal it
must pay. The higher the ratio, the easier for the company to obtain a
loan.
The formula for calculating the DSCR is as follows:
DSCR = Annual Net Operating Income / Annual Debt Payments

13. Needs of Budget for debt service funds: Debt service is the cash that is
required to cover the repayment of interest and principal on a debt for a
particular period. The Debt Service Fund is an operating fund. Upon the
establishment of the fund, annual budgets must be adopted to reflect the
anticipated activity of annual revenues and expenditures. Generally, it is
the best practice to have all debt paid from the Debt Service Fund.

14. The government traditionally issues debt to pay for capital projects for
several reasons.
 First, the cost of these projects is normally too high to absorb into an
annual budget.
 Second, due to inflationary increases, the cost of delaying a project
until it can be financed on a pay-as-you-go basis can approach the
costs of financing.
 Third, financing spreads the cost of the project to future populations
who also benefit from the use of the facility or improvement paid for
with the borrowed funds.

15. Debt Service Accounting for regular Serial Bond
A. The entry to record the budget would be-
Estimated Revenues Dr.
Appropriation Cr.
B. The entry to record when revenues are collected-
Cash Dr.
Revenues Cr.

16. C. The entry to record the fund or equity transferred from another fund
(capital project fund)-
Cash Dr.
Equity Transfer In cr.
D. When the first interest payment is legally due the debt service fund
records the expenditure of the appropriation
Expenditure- Bond Payable Dr.
Interest Payable Cr.

17. E. When interest is paid in cash-
Interest Payable Dr.
Cash Cr.
F. At the end of first-year debt service fund has no assets and no
liabilities, therefore is no need to prepare a balance sheet; but the
budgetary and operating statement accounts have balances, which are
closed by the following entry-
Revenues Dr.
Appropriation Dr.
Fund Balance Dr.
Estimated Revenue Cr.
Expenditure-Bond Interest Cr.

18. G. The Equity Transfer In must be reported in the changes in the fund
balance section of the operating statement in the following manner-
Equity transfer In Dr.
Fund Balance Cr.
Problem: 6% interest-bearing regular serial bonds (partial financing for
the fire station construction) are issued maturing in equal annual
amounts over 20 years and are registered as interest and principal. The
total face value of the issue is Tk. 1200000. Interests are payable
(semiannually) on June 15 and December 15. Bonds are sold on June 15,
20y1 at par. During 20y1 the only expenditure the Debt Service Fund
will be required to make will be the interest payment due December 15,
20y1. Assuming revenues to pay the first installment of the bond on June
15, 20y2, and both interest payments due in 20y2, will be raised in 20y2,
the budget for 20y1 need only provide revenues in the amount of the
20y1 expenditure.
You are required to make necessary journal entries for the year 20y1

19. Problem: 6% interest-bearing regular serial bonds (partial financing for the fire station
construction) are issued maturing in equal annual amounts over 20 years and are
registered as interest and principal. The total face value of the issue is Tk. 1200000.
Interests are payable (semiannually) on June 15 and December 15. Bonds are sold on June
15, 20y1 at par. During 20y1 the only expenditure the Debt Service Fund will be required
to make the interest payment due December 15, 20y1. Assuming revenues to pay the first
installment of the bond on June 15, 20y2, and both interest payments due in 20y2, will be
raised in 20y2, the budget for 20y1 need only provide revenues in the amount of the 20y1
expenditure.
You are required to make necessary journal entries for the year 20y1

20. Solution:
A. The entry to record the budget for the year ended Dec. 20y1 would be-
Estimated Revenues ………..36000
Appropriation …………………. 36000
B. If revenues in the amount of Tk. 30000 are collected from various sources
available for debt service, the entry would be-
Cash …………….. 30,000
Revenues …………30,000

21. C. If Tk. 6000 residual equity capital project fund is transferred to debt service
fund. The entry required in the latter fund is:
Cash ………………..6000
Equity Transfer In……6000
D. On Dec. 15, 20y1, when the first interest payment is legally due, the debt
service fund records the expenditure of the appropriation
Expenditure- Bond Payable ……..36000
Interest Payable ……………………36000
E. Cheques totaling Tk. 36000 are written to the registered owners of these
bonds.
Interest Payable …………….36000
Cash ……………………………..36000

22. F. As of December 31, 20y1, the debt service fund has no assets and no liabilities,
therefore is no need to prepare a balance sheet; but the budgetary and operating statement
accounts have balances, which are closed by the following entry-
Revenues …………..30000
Appropriation …… 36000
Fund Balance…….. 6000
Estimated Revenues ……………..36000
Expenditure-Bond Interest...... 36000
G. The Equity Transfer In must be reported in the changes in the fund balance section of
the operating statement. Accordingly, it is closed in the following manner-
Equity transfer In ……… 6000
Fund Balance ……………..6000

23. “One Peculiarity of the modified accrual basis used by governmental
fund types is that interest on long-term debt is not accrued.”
Example: If the fiscal of a governmental unit ends on Dec. 31 and the
interest on bonds is payable on Jan.1 and July 1 of each year, the amount
payable on Jan.1 of next year, would not be considered a liability in the
balance sheet of the debt service fund prepared as of Dec.31.
The rationale for this recommendation is that the interest is not legally
due until Jan.1 of next year.