In this video, we walk through 5 BAR practice questions on calculating total indebtedness. These questions are from BAR content area 3 on the AICPA CPA exam blueprints: State and Local Governments.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
Calculating Total Indebtedness
One of the more calculation-oriented topics in governmental accounting is determining total indebtedness reported in the government-wide financial statements. At first glance, it may seem like you only need to total a government’s bonds. In reality, total indebtedness is much broader. It includes many different obligations that require future payment, and it also requires you to recognize which items should be excluded.
Another important aspect of this topic is knowing when you can calculate total indebtedness indirectly using the government’s reported capital assets and net investment in capital assets. These questions often test whether you can distinguish between current-year activity and year-end balances.
Total Indebtedness Includes More Than Bonds
One of the biggest misconceptions is that total indebtedness only consists of long-term borrowing. While general obligation bonds and revenue bonds are certainly included, many other obligations must also be reported.
Total indebtedness includes both current and noncurrent liabilities that require future payment. The maturity of the obligation does not determine whether it is included.
Examples of items that are included include:
- General obligation bonds
- Revenue bonds
- Compensated absences
- Claims and judgments
- Lease liabilities
- Tax anticipation notes
- Accrued expenditures
- Probable claims and judgments that can be reasonably estimated
- Net OPEB liabilities
- Enterprise fund liabilities
- Other general long-term debt
For example, suppose a city reports:
- General obligation bonds: $5,000,000
- Compensated absences: $250,000
- Lease liability: $400,000
- Accrued expenditures: $150,000
Although only one of these items is a traditional bond, all four obligations represent amounts the government must eventually pay. Therefore, all four are included when calculating total indebtedness.
Current and Noncurrent Liabilities Are Both Included
You might assume that only long-term liabilities belong in total indebtedness. That is not the case.
Current liabilities remain obligations of the government even if they will be paid within the next year. Likewise, noncurrent liabilities remain obligations because they will require payment in future years.
For example, consider a city that reports:
- Current enterprise fund liabilities: $180,000
- Noncurrent enterprise fund liabilities: $520,000
Both amounts are included in total indebtedness because they are outstanding obligations reported in the government-wide financial statements.
Likewise, tax anticipation notes are generally short-term borrowings, but they are still debt because the government must repay the borrowed funds using future tax collections.
Accrued Expenditures Are Also Debt
Some obligations arise because the government has already received goods or services but has not yet made payment.
For example, assume a county receives road maintenance services before year-end but will not pay the contractor until the following month. If the county records an accrued expenditure of $300,000, that amount becomes part of total indebtedness because the government has an outstanding obligation.
Similarly, if a government expects to lose a lawsuit and the loss is both probable and reasonably estimable, the claims and judgments liability is included even if payment will not occur until the following fiscal year.
The important principle is that future payment is required because the obligation already exists.
Business-Type Activities Count Too
Government-wide financial statements combine governmental activities and business-type activities. As a result, debt reported by enterprise funds is also included in total indebtedness.
For example, a city’s water utility may have:
- Revenue bonds: $3,000,000
- Enterprise fund liabilities: $500,000
Even though these obligations belong to a business-type activity rather than governmental activities, they are still reported in the government-wide financial statements and therefore become part of total indebtedness.
Likewise, a net OPEB liability is included because it represents benefits owed to employees after retirement.
Not Everything Reported Is Included
Another common testing point is recognizing which reported amounts should not be included.
One obvious example is expenditures.
Suppose a city reports $2,000,000 of public safety expenditures during the year. That amount is not automatically included in total indebtedness because an expenditure simply reflects the use of financial resources. It does not necessarily represent an unpaid obligation at year-end.
The same idea applies to capital outlay expenditures. Purchasing a capital asset does not itself create debt. The purchase may have been financed with existing cash rather than borrowing.
Always ask yourself:
Is this an outstanding obligation requiring future payment, or is it simply an amount spent during the year?
Only the former belongs in total indebtedness.
Fiduciary and Interfund Amounts Are Excluded
Some liabilities may appear in the government’s accounting records but are not reported as part of total indebtedness in the government-wide financial statements.
Two important exclusions are:
- Fiduciary fund liabilities
- Interfund balances
Fiduciary funds are excluded because the government is holding or managing resources on behalf of others rather than carrying out its own governmental programs.
For example, if a pension trust fund reports $900,000 of liabilities, those liabilities are not included in the government’s total indebtedness.
Interfund payables are also excluded because they simply represent amounts one fund owes another fund within the same government.
For example, if the General Fund owes a Special Revenue Fund $200,000, the government does not owe an outside party. The payable is eliminated when preparing the government-wide financial statements.
Calculating Total Indebtedness Using Net Investment in Capital Assets
Some questions never list the government’s debt directly. Instead, they require you to solve for it using the net investment in capital assets.
The basic relationship is:
Net investment in capital assets = Net capital assets − Capital-related debt
If you know the first two amounts, you can solve for the third.
For example:
Net capital assets: $12,000,000
Net investment in capital assets: $7,000,000
The calculation becomes:
$7,000,000 = $12,000,000 − Debt
Debt = $5,000,000
If the problem states that the government’s only outstanding debt is capital-related debt, then that $5,000,000 is also its total indebtedness.
Thinking of the equation algebraically often makes these questions much easier:
Debt = Net capital assets − Net investment in capital assets
Pay Attention to Year-End Balances
One of the easiest traps on the BAR exam is confusing activity during the year with balances at year-end.
For example, suppose a county reports:
- Bond proceeds issued during the year: $15,000,000
- Capital outlay expenditures during the year: $15,000,000
Later in the problem, you are told:
- Net capital assets at year-end: $10,000,000
- Net investment in capital assets: $6,000,000
Some students incorrectly assume the outstanding debt is still $15,000,000 because that was the amount of bond proceeds issued.
However, the year-end balances tell a different story:
Debt = $10,000,000 − $6,000,000
Debt = $4,000,000
The amount originally borrowed does not necessarily equal the amount still outstanding. Principal may have been repaid during the year, so year-end balances control the calculation.
Combining Governmental and Business-Type Capital Assets
Some problems require an extra step before solving for debt.
Instead of providing total net capital assets, the question may separately provide information for governmental activities and business-type activities.
For example:
Governmental capital assets: $9,000,000
Business-type capital assets: $5,000,000
Total net investment in capital assets: $8,000,000
First combine the capital assets:
$9,000,000 + $5,000,000 = $14,000,000
Then solve for debt:
Debt = $14,000,000 − $8,000,000
Debt = $6,000,000
This type of question tests whether you recognize that government-wide financial statements include both governmental and business-type activities.
