Accounting practices for interest expenditures may neither reflect actual economic cost nor mirror those for interest revenues.
A town plans to borrow about $10 million and is considering three alternatives. A town official request your guidance on the economic cost of each of the arrangements, and your opinion as to how they affect the town's reported expenditures:
Alternative 1: The town would issue $10 million of 20-year, 6% coupon bonds on September 1, 2013. The bonds would be issued at par. A town would be required to make it first interest payment of $300,000 on January 1, 2014.
Alternative 2: The town would issue $10 million of 20-year, 6% bonds on July 1, 2013. The bonds would be sold for $9,552,293, a price that reflects an annual yield (effective interest rate) of 6.4%. The town would be required to make its first interest payment of $300,000 on December 31, 2013.
Alternative 3: The town would issue $32,071,355 in 20-year zero coupon bonds on July 1, 2013. The bonds would be sold for $10 million, an amount that reflects an annual yield of 6%. The bonds require no payment of principal or interest until June 30, 2032.
1. Suppose that the town elects the first option and issues $10 million in 20-year, 6% coupon bonds at par on September 1, 2013. The town establishes a debt service fund to account for resources that it sets aside to pay principal and interest on the bonds. On December 31, 2013, the town transfers $300,000 from the general fund to the debt service fund to cover the first interest payment that is due on January 1, 2014.
a. How would the transfer be reported in the general fund?
b. How would the transfer be reported in the debt service fund. What options are available to the town to record 2013 Interest in the debt service fund?