Robert Balducci, ComptrollerNew York City Municipal Water Finance Authority

Ted Williamson, Partner RubinBrown LLP

Borrowing Time: Accounting and Financial Reporting for Debt

www.gfoa.org • #GFOA2018

112th Annual ConferenceMay 6-9, 2018 • St. Louis, Missouri

Moderator/Speakers:

1:30 – 2:20 pm • May 7, 2018 • Room 223-226

GASB Statement No. 86, Certain Debt Extinguishment Issues

GASB Statement No. 88, Certain Disclosures Related to Debt, including Direct Borrowings and Direct Placements

GASB Exposure Draft, Accounting for Interest Cost During Period of Construction

Agenda

2

GASB Statement No. 86, Certain Debt Extinguishment Issues

3

Governments frequently perform in-substance defeasances:Cash or risk-free monetary assets are placed in trust

with an escrow agentFunds are used solely to pay principal and interest

on defeased debt (usually until the call date, at which point the debt is called)Trust is irrevocable and limited to owning monetary

assets that are essentially risk-free: U.S. government obligations, obligations guaranteed by the

U.S. government, securities backed by U.S. government obligations

In-Substance Defeasances

4

GASB Statements No. 7 and No. 23 provide accounting guidance on in-substance defeasances involving the issuance of refunding bonds: Refunding bonds are recorded as long-term liabilitiesDefeased bonds are removed from financial statementsAssets held in escrow are not reported as assets on the

financial statementsDifference between reacquisition price and net carrying

amount of debt is reported as a deferred inflow or outflow and amortized over time

Current GASB Guidance

5

GASB pre-agenda research in 2014 indicated inconsistencies in the application of in-substance defeasances when only existing resources are used

Project added to Board agenda in September 2015

Exposure Draft issued in August 2016

GASB Statement No. 86 issued in May 2017

Effective for periods beginning after June 15, 2017

Defeasances Using Existing Resources

6

Statement No. 86 extends existing guidance regarding in-substance defeasances to situations where only existing resources are used:Defeased debt no longer reported as a liability on the financial

statementsAssets held in trust not presented as assets on financial

statements

Important difference: Difference between reacquisition price and net carrying amount of debt is recognized as a gain or loss of the current period

Defeasances Using Existing Resources

7

Payments to escrow agents should be reported as debt service expenditures in governmental funds

Prepaid insurance related to extinguished debt (on both legal extinguishments and in-substance defeasances) should be written off and considered part of net carrying amount of debt for purpose of calculating gain or loss on refunding

Other Provisions

8

General description of transaction in the year of the defeasance:Amount of debt defeased, amount of cash and assets placed

in trust, reason for defeasance, cash flow requirements of defeased debt, etc.

In every year where defeased debt remains outstanding, report the amount of the remaining defeased debt

If substitution of essentially risk free assets with assets that are not risk-free is permitted, this fact should be disclosed in every period where the defeased debt remains outstanding

Footnote Disclosures Required

9

Obtain the trust agreement for the escrow account to understand terms and make sure it is irrevocable

Verify that assets placed into escrow meet the GASB 86 definition of being essentially risk-free

Determine whether your state and local jurisdictions permit substitution of essentially risk-free escrow investments with investments that are not essentially risk-free

Maintain payment schedule for defeased debt, to disclose amount of defeased debt still outstanding

Practical Considerations

10

Essentially eliminates advance refundings for municipal bonds by making interest on advance refunding bonds taxable

“Advance refunding” is defined as bonds issued more than 90 days in advance of the refunded bonds’ call dates

Interest on current refunding bonds (issued less than 90 days in advance of call date) remains tax-exempt

Tax Cuts and Jobs Act of 2017

11

In recent years, advance refundings had constituted a substantial portion of the bond market, as follows:

Prominence of Advance Refundings

12

Source: Municipal Securities Rulemaking Board

GASB Statement No. 88, Certain Disclosures Related to Debt, Including Direct Borrowings and Direct Placements

13

Stakeholders expressed concern regarding the absence of disclosures related to debt provisions that could impact a government’s credit profile

Particularly concerned with direct borrowings and direct placements of debt, which are becoming increasingly common

Particularly concerned with termination events and acceleration clauses that could impact liquidity

Also, inconsistency and confusion identified as to whether certain types of liabilities are “debt”

Background on Statement No. 88

14

In April 2015, GASB initiated pre-agenda research

Added to Board agenda in July 2016

Exposure Draft issued in June 2017

Statement No. 88 issued in March 2018

Effective for periods beginning after June 15, 2018

Early application is encouraged

If presentation for prior periods is not practicable, reason should be disclosed

Background on Statement No. 88 (continued)

15

Statement No. 88 defines debt as “a liability that arises from a contractual obligation to pay cash (or other assets in lieu of cash) in one or more payments to settle an amount that is fixed at the date the contractual obligation is established”

Definition excludes leases (except for contracts reported as financed purchases) and accounts payable

Any liabilities meeting the definition of debt above should have all required disclosures for debt presented in the footnotes

Definition of Debt

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In addition to existing disclosure requirements for debt, the following should be disclosed in the financial statements:Amount of unused lines of creditAssets pledged as collateral for debt Terms specified in debt agreements related to: Events of default with finance-related consequences Termination events with finance-related consequences Subjective acceleration clauses

New Disclosure Requirements

17

Governments should separate information in debt disclosures regarding:Direct borrowings and direct placements of debtOther debt

Definitions:Direct borrowings and direct placements have terms

negotiated directly with the investor or lender and are not offered for public saleDiffers from bonds and similar instruments, which are offered for

sale in the public bond markets

Separate Presentation

18

Inventory all liabilities and determine whether they meet the definition of debt under GASB 88

For any liabilities not previously classified as debt, make sure information is available to prepare all required disclosures Particularly, increases and decreases in liability for year

Review agreements for all debt instruments to determine if there are assets pledged as collateral, events of default, termination clauses, or subjective acceleration clauses

Practical Considerations

19

GASB Exposure Draft, Accounting for Interest Cost During Period of Construction

20

Currently governments capitalize interest cost incurred during the period of construction for business-type activities and enterprise funds

GASB Statement 62 currently provides guidance

Guidance is based on Financial Accounting Standards Board (FASB) Statements No. 34, Capitalization of Interest Cost, and No. 62, Capitalization of Interest Cost in Situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants, which were issued in 1979 and 1982, respectively

Practice Issue

21

ComparabilityCapital asset information in government-wide financial

statements is different from business-type financial statements Historical costs for identical assets can be misleading

GASB added to agenda December 2016 Issued an Exposure Draft November 20, 2017 Accounting for Interest Costs during the Period of Construction

Comment deadline was March 5, 2018GASB deliberations in April

Practice Issue (continued)

22

GASB 62 (paragraph 5-22) established standards capitalizing interest costs on certain assets Establish interest rate or capitalization rate Based on rates applicable to borrowings during the period

Establish an accounting period or capitalization period Based on payments made for activities necessary to get the asset

ready for it intended use while interest costs are being incurred (CWIP)

Apply capitalization rate to capitalization period

Current Practice – GASB 62

23

Objectives To enhance the relevance and comparability of information

about capital assets and the cost of borrowing for a reporting period To simplify accounting for interest cost incurred during the

period of construction

Proposed standard would supersede existing guidance under GASB Statement 62

Proposed New Guidance

24

GASB reconsidered Statement 62 requirements for business-type activities and enterprise funds and determined: Interest costs incurred during construction is not an asset as

defined by Concepts Statement No. 4 Elements of Financial Statements Does not enhance present service capacity

Interest costs incurred during construction is not a deferred outflow of resources as defined by Concept Statement No. 4 Is not a consumption of net assets that is applicable to a future

reporting period

GASB Considerations

25

Interest cost incurred during construction meets the definition of an outflow of resources as defined by Concept Statement No. 4 Is a periodic cost applicable to the current reporting period

Other ConsiderationsGASB concluded that interest costs associated with the

financing of a capital asset are different from ancillary charges such as freight or transportation charges GASB believes proposed statement eliminates the complex

accounting for capital assets

GASB Considerations (continued)

26

Financial statements prepared using the economic resources measurement focus: Recognize interest costs incurred during the period of

construction as an expense

Financial statements prepared using the current financial resources measurement focus: Recognize interest costs incurred during the period of

construction as an expenditure consistent with governmental fund accounting principles

Guidance Provisions

27

Apply prospectively Interest costs incurred after beginning of the first reporting

period should not be capitalized Existing capitalized interest should not be written off

Not applicable to BTAs that have regulated operations

Guidance Provisions

28

Simplifies accounting

Considerations:Determine if accounting system needs reprogrammingDetermine whether new guidance will impact rate setting

Effect of New Guidance

29

www.gfoa.org • #GFOA2018

112th Annual ConferenceMay 6-9, 2018 • St. Louis, Missouri

Questions:Speakers will take questions and comments. This session is being recorded, please utilize the microphone in the aisle to ask all questions.

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Speaker Contact Information:

Robert BalducciEmail: BalducciR@omb.nyc.govPhone:  212‐788‐6015

Ted WilliamsonEmail: ted.williamson@rubinbrown.comPhone:  314‐678‐3534

Contact GFOA: To contact GFOA about session topics please email research@gfoa.org