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Business and Policy Areas
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New GASB Standard Addresses In-Substance Debt Defeasance

May 26, 2017

To achieve consistency in accounting treatment for the defeasance of debt regardless of whether the funds were obtained from new borrowing or allocated from existing resources, the Governmental Accounting Standards Board (GASB) issued Statement No. 86 “Certain Debt Extinguishment Issues” on May 15.

Statement 86 recognizes a debt defeasance when a governmental entity's own resources are set aside in a trust (escrow) for the future repayment of outstanding debt, (i.e., an “in-substance defeasance”).

Background
In general, defeasance is a provision that voids existing debt when a borrower sets aside amounts sufficient to service the borrower’s remaining debt. Prior to issuance of Statement 86, a governmental entity could only consider debt extinguished through defeasance when the proceeds of a refunding arrangement were set aside in a trust and used to pay down the debt over its remaining life.

As a result of significantly increased debt refunding activity since 2008, GASB observed that some governments were reporting a defeasance when their own resources were used, via a trust, to service existing debt while others were not. After research, stakeholder outreach, and deliberations, GASB concluded that an in-substance defeasance exists when cash and other monetary assets acquired with only existing resources are placed in a trust to extinguish debt. Further, an in-substance defeasance should not result in different financial statement recognition.

Guidance
Under Statement 86, governments can set aside existing resources in a trust to accomplish the same purpose as a bond refunding for defeasance. The monetary assets placed in the trust must be risk-free for the purpose of timing and amount of payments, and must be in the same currency in which the debt is payable.

Public institutions reporting as a Business Type Activity will recognize a gain or loss in the period in which the in-substance defeasance occurred. The gain or loss is the difference between the reacquisition price (the amount required to repay previously issued debt) and the net carrying amount (the amount due at maturity, adjusted for any unamortized premium or discount and any remaining deferred outflows or deferred inflows of resources). The net carrying amount of the extinguished debt also includes any remaining prepaid insurance.

Disclosures in the notes to the financial statements for the year in which the transaction occurred include a general description of the transaction—generally the amount of the debt, the amount of monetary assets placed in escrow, the reason for the transaction, and the cash flows required to make the payments on the defeased debt. Disclosures in subsequent years must include the amount of in-substance defeased debt that remains outstanding at the end of the period.  

Statement 86 is effective for fiscal years beginning after June 15, 2017, FY18 for the vast majority of public institutions, with early application encouraged. Changes adopted to conform to the standard’s guidance should be applied retroactively by restating financial statements for earlier periods reported. If restatement is not possible, any cumulative effect should be reported as a restatement of beginning net position for the applicable reporting period. Statement 86 is available for download from GASB's website.

Contact

Sue Menditto
Director, Accounting Policy
202.861.2542
E-mail