Debt Service Fund
A Debt Service Fund is a type of fund used primarily by governmental entities to account for the accumulation of resources and payment of principal and interest on long-term general obligation debt.
When a municipality or other governmental entity issues bonds or takes on other forms of debt to fund projects such as the construction of schools, roads, or other public works, they will often establish a debt service fund.
Revenues from taxes, special assessments, or other income sources are directed into this fund. The money in the fund is then used exclusively to make interest payments and to repay the principal on the debt as it becomes due.
The use of a debt service fund helps ensure that the government entity will have enough money set aside to meet its debt obligations, and it provides transparency and accountability, showing taxpayers that the funds are being used for their intended purpose. It’s part of good fiscal management and is often required by law for certain types of debt.
Example of a Debt Service Fund
Let’s consider a hypothetical example.
Suppose a city decides to issue $10 million in bonds to finance the construction of a new public library. The bonds are to be repaid over 20 years, with interest payments due semiannually and principal payments due annually.
To manage the repayment of these bonds, the city sets up a Debt Service Fund. Each year, a portion of the city’s property tax revenue is allocated to this fund. The amount is calculated based on the annual principal and interest payments that the city will need to make.
Throughout the year, the money accumulates in the Debt Service Fund. When it’s time to make an interest or principal payment on the bonds, the payment is made from this fund. The city’s finance department also prepares regular reports showing the inflows and outflows of the fund, providing transparency for city officials and residents.
By using the Debt Service Fund, the city ensures that it always has money set aside for its bond payments. This helps maintain the city’s good credit rating and shows its commitment to fiscal responsibility.