Borrowing Time: Accounting and Financial Reporting for Debt

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Tobias Barnett
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1 1:30 2:20 pm May 7, 2018 Room th Annual Conference May 6-9, 2018 St. Louis, Missouri Moderator/Speakers: Robert Balducci, Comptroller New York City Municipal Water Finance Authority Ted Williamson, Partner RubinBrown LLP Borrowing Time: Accounting and Financial Reporting for Debt #GFOA2018

2 Agenda 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 2

3 GASB Statement No. 86, Certain Debt Extinguishment Issues 3

4 In-Substance Defeasances Governments frequently perform in-substance defeasances: Cash or risk-free monetary assets are placed in trust with an escrow agent Funds 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 4

5 Current GASB Guidance 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 liabilities Defeased bonds are removed from financial statements Assets held in escrow are not reported as assets on the financial statements Difference between reacquisition price and net carrying amount of debt is reported as a deferred inflow or outflow and amortized over time 5

6 Defeasances Using Existing Resources 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,

7 Defeasances Using Existing Resources 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 statements Assets 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 7

8 Other Provisions 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 insubstance defeasances) should be written off and considered part of net carrying amount of debt for purpose of calculating gain or loss on refunding 8

9 Footnote Disclosures Required 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 9

10 Practical Considerations 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 10

11 Tax Cuts and Jobs Act of 2017 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 11

12 Prominence of Advance Refundings In recent years, advance refundings had constituted a substantial portion of the bond market, as follows: Source: Municipal Securities Rulemaking Board 12

13 GASB Statement No. 88, Certain Disclosures Related to Debt, Including Direct Borrowings and Direct Placements 13

14 Background on Statement No. 88 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 14

15 Background on Statement No. 88 (continued) 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 15

16 Definition of Debt 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 16

17 New Disclosure Requirements In addition to existing disclosure requirements for debt, the following should be disclosed in the financial statements: Amount of unused lines of credit Assets 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 17

18 Separate Presentation Governments should separate information in debt disclosures regarding: Direct borrowings and direct placements of debt Other debt Definitions: Direct borrowings and direct placements have terms negotiated directly with the investor or lender and are not offered for public sale Differs from bonds and similar instruments, which are offered for sale in the public bond markets 18

19 Practical Considerations 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 19

20 GASB Exposure Draft, Accounting for Interest Cost During Period of Construction 20

21 Practice Issue 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 21

22 Practice Issue (continued) Comparability Capital 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, 2018 GASB deliberations in April 22

23 Current Practice GASB 62 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 23

24 Proposed New Guidance 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 24

25 GASB Considerations 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 25

26 GASB Considerations (continued) 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 Considerations GASB 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 26

27 Guidance Provisions 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 27

28 Guidance Provisions 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 28

29 Effect of New Guidance Simplifies accounting Considerations: Determine if accounting system needs reprogramming Determine whether new guidance will impact rate setting 29

Speaker Contact Information: Robert Balducci Email: BalducciR@omb.nyc.gov Phone: 212 788 6015 Ted Williamson Email: ted.williamson@rubinbrown.

30 Speaker Contact Information: Robert Balducci Phone: Ted Williamson Phone: th Annual Conference May 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. Provide Feedback: Please take a few minutes to provide your feedback at Discuss/Comment: Join the discussion at #GFOA2018 Contact GFOA: To contact GFOA about session topics please research@gfoa.org #GFOA2018

GASB & AUDIT UPDATE NOVEMBER 2018

GASB & AUDIT UPDATE NOVEMBER 2018 Alaska Government Finance Officers Association BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited