Accounting Update: New Guidance Brings Consistency to Methods of Repaying Debt

Introduction

On May 15, the Governmental Accounting Standards Board (GASB) issued guidance that aims to improve consistency for the ways state and local governments account for methods of paying off debt. GASB Statement 86, Certain Debt Extinguishment Issues, establishes uniform guidance for derecognizing debt that is defeased in substance, regardless of how cash placed in an irrevocable trust for the purpose of extinguishing that debt was acquired.

OBSERVATION: “Defeasance” is a provision that voids a bond or loan when the borrower sets aside cash or bonds sufficient enough to service the borrower’s debt. It is also referred to as “defease.” The borrower sets aside cash to pay off the bonds; therefore, the outstanding debt and cash offset each other on the balance sheet and do not need to be recorded.

Key Points

GASB Statement 7, Advance Refundings Resulting in Defeasance of Debt, requires that debt be considered defeased in substance when the debtor irrevocably places cash or other monetary assets acquired with refunding debt proceeds in a trust to be used solely for satisfying scheduled payments of both principal and interest of the defeased debt. Statement 86 establishes essentially the same requirements for when a government places cash and other monetary assets acquired with only existing resources in an irrevocable trust to extinguish the debt.

Governments that defease debt using only existing resources should provide a general description of the transaction in the notes to financial statements in the period of the defeasance. In all periods following an in-substance defeasance of debt using only existing  resources, the amount of that debt that remains outstanding at period-end should be disclosed.

Effective Date and Transition

The provisions of Statement 86 are effective for reporting periods beginning after June 15, 2017. Earlier application is encouraged.

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