ch08 - Chapter 8 Long-Term Obligations Questions for Review...

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Chapter 8 Long-Term Obligations Questions for Review and Discussion 1. Unlike businesses, governments have the power to tax and, at least in theory, their available resources are limited only by the wealth of their constituents. At the same time, governments are charged with providing services, some of which, unlike those provided by businesses, are essential to the public well-being and therefore cannot be discontinued. Nevertheless, there are practical constraints on what they can demand from their constituents and there may be considerable room for expenditure cuts before the well being of the community is imperiled. The crucial issue, therefore, involves balancing the needs and resources of the populace and the demands of the creditors. 2. General long-term debt is the obligation of the government at-large and is thereby backed by the government’s full faith and credit. Revenue debt, by contrast, is secured only by designated revenue streams, such as from the sale of electricity, highway tolls, rents, receipts from student loans or patient billings. Because revenue debt is less secure than GO debt, it almost always commands higher interest rates. Yet, if a single entity were to issue only general obligation debt its total interest costs would likely be the same as if it were to issue a mix of both types. 3. The government would report the bonds at their face value plus or minus any unamortized premiums or discounts. This amount differs from face value in that it takes into account the unamortized premiums or discounts. It differs from market value in that market value is equal to the present value of all required cash payments discounted by a prevailing interest rate. Book value, however, is equal to the present value of all required cash payments discounted by the interest rate that determined the price of the bond when it was first issued (i.e., the yield rate). 4. The interest expenditure as reported in the debt service fund (a governmental fund) would be equal to the required cash payment. That reported in the government-wide statements would be equal to the required cash payment plus or minus the amortization of the discounts or premiums — an amount also equal to the book value of the debt times the initial yield rate. 5. Demand bonds are obligations that permit the holder (the lender) to demand redemption within a specified period of time, usually one to 30 days, after giving notice. The issuer can report them as long-term obligations if it has entered into a qualifying take-out agreement (one that is noncancellable, doesn’t expire for at least a year, and is with an institution fiscally capable of honoring it). 6. The courts, not GAAP, determine the types of obligations subject to debt limitations. In many jurisdictions the courts have focused on the nonappropriation 8-1
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clauses included in capital leases, rather than on the economic substance of those leases. The nonappropriation clauses permit governments to cancel the leases if the legislature fails in any year to appropriate the required funds for the lease payments.
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