Questions for Review and Discussion
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.
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.
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).
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.
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).
The courts, not GAAP, determine the types of obligations subject to debt
limitations. In many jurisdictions the courts have focused on the nonappropriation