Chapter 7 LOCAL AGENCY BONDS AND LOCAL TRANSPORTATION REVOLVING LOAN FUND

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1 7.1 Chapter 7 LOCAL AGENCY BONDS AND LOCAL TRANSPORTATION REVOLVING LOAN FUND LOCAL AGENCY BONDS NARRATIVE Periodically, due to a cash flow need, the county may sell debt (bonds) with the assistance of financial advisers to finance one or more projects. The State of Minnesota is not a party to any bond issue made by a local government agency, but the annual State Aid Allotments can sometimes be used for repayment of the debt. It is important to understand that there are accounting guidelines to be followed to accurately record the bond proceeds, bond expenditures, and any revenue that may be earned from interest. There are tax implications to be tracked, public reporting that may be requested showing bond uses, and of course the need for the Highway Department to accurately record the value added to their road system. Each county will have their own unique set of procedures. Prior to bond issue it is important that each department understand its responsibility in the process to avoid duplication as well as omission of important steps. This chapter will address two types of bonds often used by counties. The difference between the two is the pledge for the source of repayment. Determining the type of bond to be issued looks at the use of the funds and the sources available for repayment. In both cases, once the county determines that it will issue bonds a financial advisor is contacted and the bond issue process begins following similar steps up through the point of sale. General Obligation (G.O.) Bonds are backed by a pledge of the full faith and credit of the county and thus generally repaid with property tax levies. These bonds can be used for very broad purposes depending on the county s financial plan and structure. Accounting for G.O. bonds will be an internal function and no reporting or compliance will be required by State Aid. They are included here as a part of the Highway Department s possible accounting entries throughout the bond s life. Local Agency Bonds (L.A.) are Revenue Bonds for which the county has pledged repayment with the county s available annual construction and maintenance allotments. These bonds must be used for the purposes stated in MN statute ; establishing, locating, relocating, constructing, reconstructing and improving county state aid highways and constructing buildings and other facilities for maintaining county state aid highways. This statute, along with MN State Aid Rule Subp. 11, also establish a limit on the bond principal amount that can be considered for issue. State Aid requires a repayment schedule of principal and interest be provided within 30 days of the bond issue. This schedule is used to verify and set aside annual payments that will be released to the county for their repayment of the bond principal and interest. Sometimes in order to secure a lower interest rate, a County will issue G.O. Revenue Bonds, which pledge the allotments for the repayment of the bonds, but includes a secondary pledge of the county s taxing authority.

2 7.2 ACCOUNTS NEEDED (expenditure) (expenditure) (expenditure) (revenue) (revenue) (revenue) (asset) (asset) (asset) (asset) (deferred inflow) (deferred inflow) (equity) (equity) (equity) (other sources/uses) - BOND INTEREST EXPENDITURES - BOND ISSUANCE COSTS - BOND PRINCIPAL RETIREMENT - APPROPRIATE CONSTRUCTION REVENUE - APPROPRIATE MAINTENANCE REVENUE - INVESTMENT INTEREST REVENUE - CASH - APPROPRIATE CONSTRUCTION ALLOTMENT - APPROPRIATE MAINTENANCE ALLOTMENT - INVESTED BOND FUNDS - APPROPRIATE CONSTRUCTION UNAVAILABLE REVENUE - APPROPRIATE MAINTENANCE UNAVAILABLE REVENUE - ASSIGNED FUND BALANCE - RESTRICTED FOR CONSTRUCTION - RESTRICTED FOR DEBT SERVICE - OTHER FINANCING USES - TRANSFERS OUT - OTHER FINANCING SOURCES - TRANSFERS IN - OTHER FINANCING SOURCES - BONDS ISSUED - OTHER FINANCING USES DISCOUNT ON BONDS ISSUED - OTHER FINANCING SOURCES PREMIUM ON BONDS ISSUED SEQUENCE OF EVENTS Entries are the same for both general obligation and local agency bonds from the bond issue through the bond expenditure. The differences lie in the annual bond repayment accounting. Entries here are provided for the Highway Department Accounts only and are provided as guidance; actual account titles will vary. BOND ISSUE If the bond funds are receipted in the Auditor s Office for the bond issuance, no entries are made at the Highway Department at this time. When bonds are sold and the cash is received by the Highway Department it is considered an Other Financing Source, not operating revenue. The bond issuance costs may or may not be a part of the Highway Department entry. If the funds are transferred from another fund, the expense may have been recorded there and should not be duplicated.

3 7.3 Record the issue of bonds and the related issue costs (expense) Bond Issue Costs Credit Account: (nonoperating) Other Financing Sources Bonds Issued Bonds issued in a favorable market can create a premium meaning they sold for more than the face value of the bonds, providing additional funds for the county. If the market is unfavorable the bond may sell at a discount, or for less than the face value of the issue. In both cases this would be recorded with an additional line to the journal entry above for Other Financing Sources Bonds Issued as a credit for a premium issue or a debit in the case of a discounted issue. It is required to break this amount out in the accounting record for tracking. The funds received from a bond issue are often recorded into a Construction Account within the Highway Fund that tracks revenues and expenditures impacting the bond proceeds used for construction. If the Highway Department receipted the face value of the bond funds (above) this entry would be made to establish a Construction Account. Record the issue of bonds and the related issue costs Debit Account: (equity) Credit Account: (equity) Assigned Fund Balance Restricted for Construction INVESTED FUNDS If invested funds that are not recorded by the Highway Department no entries would be made. It is not uncommon for bond funds to be invested immediately to earn interest revenue until they are expended. In the case of general obligation bonds all revenue earned is generally returned to the Debt Service Fund to be used for future payments. This is not the case for local agency bonds as long as their future payments are satisfactorily secured by the annual allotments. Record the investment of bond proceeds Invested Bond Funds When investments earn interest income that is booked in the Highway Department s Debt Service Fund/Accounts. Record the investment revenue Investment Interest Revenue

4 7.4 Record the investment revenue Investment Interest Revenue Transfer interest income to the Debt Service fund Debit Account: (Non- Operating) Credit Account: (equity) Other Financing Uses Transfers Restricted Debt Service Fund CONTRACT PAYMENTS ARE PROCESSED The Highway Department processes all the normal entries for contract expenditures through the project. (see Chapters 3 and 4). When the bond funds are held in a fund at the Auditor s Office, it is likely that a request to transfer funds will need to be made to reimburse the funds that the Highway Department has paid out to the contractor or has certified. Recognize funds transferred into the Highway Department to cover construction expenditures Credit Account: (Non- Other Financing Sources Transfers In Operating) When the bond funds are held in the Highway Department, no additional entries are required. ANNUAL PRINCIPAL AND INTEREST PAYMENTS GENERAL OBLIGATION BONDS (G.O.) During the year, funds from a predetermined repayment source will be deposited into the Debt Service Fund in anticipation of the payment of principal and interest due that year. There are numerous revenue sources and variations on where and when they are recorded. If the Debt Service Fund is recorded in the Auditor s Office, the Highway Department will not make any entries for the accrual of revenue throughout the year or the annual payment of interest or principal on the bond. These accounts will be tracked in another fund. If revenues are collected in another fund and transferred to a Debt Service Fund in the Highway Department, it is likely that a request to transfer funds will need to be made to initiate the transfer.

5 7.5 Recognize funds transferred into the Highway Department to cover the annual principal and interest Credit Account: (Non- Other Financing Sources Transfers In Operating) When the Debt Service Fund is recorded in the Highway Department, the current portion of the bond principal and interest will need to be paid to the bond company. Record payment of the current portion of bond principal Debit Account: (expense) Bond Principal Retirement Record payment of the current portion of bond interest Debit Account: (expense) Bond Interest LOCAL AGENCY BONDS (L.A.): In compliance with Minnesota Statute , the county can use its appropriate annual construction allotment to make bond principal payments and its appropriate annual maintenance allotment to make the bond interest payments. At year end the amount paid for interest will be separated from maintenance expenditures on the Annual Summary of Highway Maintenance Expenditures. ALLOTMENT SET ASIDE: The amount of principal and interest due annually are set aside by State Aid Finance each January when the new allotments are issued. If a county is advancing, the advance will be repaid first and the bond principal will be set aside. The construction allotment will be allowed to go negative for the bond principal set aside, but the interest payment will be paid short if there are insufficient funds in the maintenance allotment. The county should book the bond set aside when it occurs in January so that it will balance monthly to the allotment accounts. Record the reduction of the construction allotment for the bond principal due in the current year Debit Account: (deferred inflow) Appropriate Construction Unavailable Revenue Appropriate Construction Allotment

6 7.6 Record the reduction of the construction allotment for the bond interest due in the current year Debit Account: (deferred inflow) Appropriate Maintenance Unavailable Revenue Appropriate Maintenance Allotment STATE AID RELEASES BOND PRINCIPAL AND INTEREST State Aid Finance will hold the set aside bond funds until the county submits the Affidavit to Request Bond Payment. Once that form is received the payment is released to the county. The Affidavit must be submitted about 30 days prior to each payment release, generally twice a year per bond. In many counties the payments from State Aid are receipted at the Auditor s Office and deposited into the Highway Fund. If the Auditor will be issuing the bond payments, the funds can be deposited directly into the fund the payments will be made from, avoiding the need for an additional transfer. The Highway Department would then recognize the appropriate revenue, but the interest expense and the Debt Service Fund would be recorded in the other fund. Record revenue earned for bond principal payment Debit Account: (nonoperating) Other Financing Uses Transfers Appropriate Construction Revenue Record revenue earned for bond principal interest Debit Account: (nonoperating) Other Financing Uses Transfers Appropriate Maintenance Revenue If the Highway Department is recording the Debt Service activity and will be issuing the bond payments, the revenue, debt service and interest expense entries will be made on the Highway Department books. Record cash received and corresponding revenue for the bond principal Appropriate Construction Revenue Record cash received and corresponding revenue for the bond interest Appropriate Maintenance Revenue

7 7.7 COUNTY MAKES BOND PRINCIPAL AND INTEREST PAYMENT Record the payment of the bond principal and interest to the bonding company Debit Account: (expense) (expense) Bond Principal Bond Interest APPLYING BOND FUNDS In the State Aid Accounting System (SAAS) there are two balances tracked for a single bond principal. The first is the Outstanding Bond Principal that will be reduced annually with the bond principal payments and reflects the remaining debt to be paid by the county. The second is the Unapplied Bond Principal that is reduced when the county submits a State Aid Payment Request and states that bond funds have been applied to eligible project costs. State Aid must insure that the funds paid annually for bond principal and interest from State Aid Allotments are being spent for the legal purposes defined in MN statute In the SAAS Reports Menu, there is a report listing the projects and amounts that the county has paid using bond funds rather than State Aid Funds. If a county has more than one unapplied bond, funds are applied to the oldest bond first. The bond is not considered completely satisfied until both the Outstanding Bond Principal and the Unapplied Bond Principal reach zero. REFUNDING BONDS During the life of a bond the county may refund or refinance the bond for a better interest rate or to restructure debt. In this process, the unpaid bond principal is in essence paid in full with the issue of the new bond. This is not done without a fee, and the bond issue fee is often added to the existing bond principal. If the bond issue fees will be paid from State Aid Allotments, the county must be aware that there is additional principal to be Applied. State Aid considers a bond refund to be the same as a new bond issue and requires the same information to be submitted.

8 7.8 YEAR END REPORTING On the Annual Summary of Maintenance Costs for the county, bond interest should be reported separately in such a way that it is not added into the calculation for the county's average cost per mile figure for road maintenance. The inclusion of these figures would inflate the county s average maintenance costs per mile.