Assume that the investment of $10,000 at a $200 premium is to be held for four years. The entry to amortize the premium at the end of the first year is as follows:

Unamortized premium on investments $50

Revenue from interest $50

To amortize one-fourth of the premium on investments

Question

Assume that the investment of $10,000 at a $200 premium is to be held for four years. The entry to amortize the premium at the end of the first year is as follows:

Unamortized premium on investments $50

Revenue from interest $50

To amortize one-fourth of the premium on investments

Accepted Answer

Observe that the reserve for debt retirement balance is in agreement with the debt service fund accumulation schedule at the end of each year throughout the outstanding life of the bonds. In this illustration, a favorable variance of $100 exists at the end of the second year. In future years, revenue from taxation or revenue from earnings may fall short of the requirements of the debt service fund accumulation schedule or losses may occur when converting investments into cash. In the event that the unappropriated debt service fund balance develops a deficit (a debit balance) attention of the board would be focused on the unfavorable variance and corrective action could be taken by the board of education.

The bond prospectus usually restricts the debt service fund to certain kinds of investments—investments that are conservative, yet able to provide income for the debt service fund. If investments in bonds are authorized, they may be purchased at a price in excess of face value (called a premium) or they may be purchased at a price less than face value (called a discount). An additional characteristic of investment in bonds is that if they are purchased between interest payment dates, interest accrued since the authorized date of issue or since the last interest payment date is included in the purchase price. The following illustrations will record purchase at a premium, purchase at a discount and purchase including accrued interest to date of purchase.

When long-term investments are made at a discount or a premium, the discount or premium affects the amount of interest that will be earned on the investment. A prorata share of the discount or premium should be amortized or written off each year over the remaining outstanding life of the investment. Amortization of the premium or discount changes the rate of interest from the nominal rate (i.e., the rate stated on the face of the investment) to an effective rate of interest. Amortization of a discount increases the nominal rate of interest to the effective rate of interest while amortization of a premium decreases the nominal rate of interest to the effective rate of interest. In either case, interest earned each interest period on each investment will be the same amount, leaving the investment recorded at its maturity value.
Over the outstanding life of the investment, the discount or the premium will be written off through the revenue from the interest earned account. Each year the general fund makes provision in its budget for the amount required to retire bonds maturing during the budget period, and it may also make provisions to pay interest on general obligation bonds. The general fund’s appropriation accounts record authorization to make such expenditures during the fiscal year. Later during the year, the general fund will actually disburse money in payment of bond principal, and interest on bonded indebtedness

When this occurs, business papers that give evidence that the transactions have occurred are prepared and support the following entry in the general journal:
Serial bonds payable $20,000
Amount to be provided for bond retirement $20,000
To record general fund’s payment for retirement of matured serial bonds

Each year the preceding entry is made. Ultimately, the bonds payable account is eliminated as a result of annual retirement of the bonds. Each year the balance of the account titled “amount to be provided for bond retirement” is reduced by the corresponding amount, ultimately eliminating it.

In the case of long-term bonds being retired by use of a debt service fund, it is possible that the general fund or a tax collection agency fund may serve as the agent to collect taxes for the debt service fund. In other cases, the debt service fund may collect its own taxes. In either case, however, taxes must be levied in an amount that sufficient assets can be accumulated over the life of long-term bonds in debt service funds to retire them at maturity.

At the end of the fiscal period, the debt service fund’s accounts are closed and the amount actually accumulated during the year for retirement of the long-term bonds is reflected in the accounts.

To record the amount accumulated each year in the debt service fund, the following entry is made in the accounts of the general long-term debt group of accounts:
Amount provided in debt service fund—bond retirement $29,865
Amount to be provided for bond retirement $29,865
To record the amount provided by taxes and earnings in the debt service fund for retirement of long-term bonds

Because interest is paid annually by the general fund or debt service fund on both serial and long-term bonds, entries that reflect the transactions involving interest on general long-term debt are not, necessarily, made a formal part of this group of accounts. However, accounts that reflect the interest status may be effective management instruments.

Each year as payments are made by the general fund or the tax collection agency fund to the debt service fund or as the debt service fund assesses, levies and collects its own taxes and earns interest on its investments, the account titled “amount provided in debt service fund for bond retirement” is increased. At the maturity date of the long-term bonds, the amount provided in the debt service fund for bond retirement should equal the maturity value of the long-term bonds. Textbox 14.2 shows how the accounts relative to the bond issue appear at the maturity date of the long-term bonds.

Question 14.8: Assume that the investment of $10,000 at a $200 premium is t...

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