Transactions known as advance refundings of debt are one of the unique types of accounting transactions often found in the debt service funds. This topic is closely related to the requirements of GAAP as to when the refunded debt can be removed from the government-wide statement of net assets. Statement No. 7 of the GASB “Advance Refundings Resulting in Defeasance of Debt” (GASBS 7), provides the accounting rules for these types of transactions.

An advance refunding transaction typically involves a government issuing new debt and using the proceeds to pay off (refund in advance) an existing debt issue. Since the bonds for the existing debt issue have not matured, the government takes the proceeds from the new bonds and places a sufficient amount of these funds in a trust. As the bonds and debt service from the existing bonds become due, they are paid with the funds that the government had put in the trust. Basically, the government has substituted the new debt for the existing debt.

There are two ways that the government could remove the liability for the old debt from the statement of net assets. The first, called a legal defeasance, occurs when debt is legally satisfied based on provisions of the debt instrument or contract even though the debt has not actually been paid. This situation does not occur frequently. The second, called an in-substance defeasance, is far more common. An in-substance defeasance occurs when debt is considered defeased for accounting purposes even though a legal defeasance has not occurred.

Taken From : Governmental Accounting Made Easy

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