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Glenn Hegar  ·  Texas Comptroller of Public Accounts

Reporting Requirements for Annual Financial Reports of State Agencies and Universities

General Accounting

Specialized Accounting
Certain Debt Extinguishment Issues

In order to improve consistency in accounting and financial reporting for in-substance defeasance of debt, GASB 86 establishes accounting standards for transactions in which cash and other monetary assets acquired with only existing resources (resources other than the proceeds of refunding debt) are placed in an irrevocable trust for the sole purpose of extinguishing debt. GASB 86 also improves accounting and financial reporting standards for prepaid insurance on debt that is extinguished and notes to financial statements for debt that is defeased in substance.

Scope and Applicability

The accounting and financial reporting is for debt that is extinguished — whether through a legal extinguishment or through an in-substance defeasance — regardless of how the cash and other monetary assets were acquired. GASB 86 establishes an additional disclosure requirement related to debt that is defeased in substance. The requirements of GASB 86 apply to financial statements for all state agencies.

GASB 86 amends:

In-Substance Defeasance of Debt

Debt is defeased in substance if the agency irrevocably places cash and other monetary assets acquired with only existing resources — meaning resources other than the proceeds of refunding debt — with an escrow agent in a trust. The purpose of the trust is only for satisfying scheduled payments of both interest and principal of the defeased debt. The possibility that the agency will be required to make future payments on the debt is remote. The trust is restricted to owning only monetary assets that are essentially risk-free as to the amount, timing, and collection of interest and principal. The monetary assets should be denominated in the currency in which the debt is payable. For debt denominated in U.S. dollars, essentially risk-free monetary assets are limited to the following classifications:

  • Direct obligations of the U.S. government
  • Obligations guaranteed by the U.S. government
  • Securities backed by U.S. government obligations as collateral and for which interest and principal payments on the collateral generally flow immediately through to the security holder

In addition, the monetary assets held by the trust are required to provide cash flows (from interest and maturity of those assets) that approximately coincide (as to timing and amount) with the scheduled interest and principal payments on the defeased debt. However, some securities described above can be paid before their scheduled maturities and thereby are not essentially risk-free as to the timing of the collection of interest and principal.

For example: if the above securities are callable, then there is no assurance that the reinvested funds would provide the yields necessary to meet the required debt service payments. When this occurs, the security(ies) do not qualify as monetary asset(s) for defeasance purposes.

Recognition in Financial Statements Using the Economic Resources Measurement Focus (Full Accrual)

When an agency places cash (and other monetary assets acquired with only existing resources) with an escrow agent in a trust that meets the criteria in the previous paragraphs for an in-substance defeasance, the agency does not report the debt as a liability in the financial statements. Any difference between the reacquisition price and the net carrying amount of the debt (together with any deferred outflows of resources or deferred inflows of resources from prior refundings) are recognized as a separately identified gain or loss in the period of the in-substance defeasance.

Recognition in Financial Statements Using the Current Financial Resources Measurement Focus (Modified Accrual)

Report the payments to the escrow agent made from existing resources as debt service expenditures in the financial statements.

Notes to Financial Statements

Agencies that defease debt (using only existing resources) must provide a general description of the transaction in the notes to financial statements in the period of the defeasance. A general description of the transaction may include information such as the:

  • Amount of the debt
  • Amount of cash (and other monetary assets acquired with existing resources) placed with the escrow agent
  • Reasons for the defeasance
  • Cash flows required to service the defeased debt

In all periods following an in-substance defeasance of debt (using only existing resources), agencies must disclose the amount of that debt defeased in substance that remains outstanding (if any) at fiscal year-end. As required by GASB 7, paragraph 14, agencies report this amount (if backed by risk-free monetary assets) with the amount of debt defeased in substance through refunding transactions that remain outstanding.

Prepaid Insurance Related to Extinguished Debt

Agencies that extinguish debt (whether through a legal extinguishment or through an in-substance defeasance) must include the amount of any remaining prepaid insurance related to the extinguished debt in the net carrying amount of that debt for the purpose of calculating the difference between the reacquisition price and the net carrying amount of the extinguished debt.

Additional Disclosure for All In-Substance Defeasance Transactions

If applicable, agencies must disclose the substitution of essentially risk-free monetary assets with monetary assets that are not essentially risk-free in the period in which debt is defeased in-substance.

In all periods following an in-substance defeasance, agencies must disclose the amount of debt defeased in-substance that remains outstanding (if any) where a non-risk-free substitution exists. As required by GASB 7, paragraph 14, and GASB 86, paragraph 8, disclose that amount separately from the total amount of debt defeased in substance that remains outstanding.

Glenn Hegar
Texas Comptroller of Public Accounts
Questions? Contact statewide.accounting@cpa.texas.gov
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