Long-term obligations: what are the reasons for leasing?
- (1) need an asset for only a small part of its useful life
- (2) wish to avoid risks of ownership, such as declines in market value & technological obsolecence
- (3)they have neither available cash nor credit to purchase asset
What are the comparative advantages of GO (general obligation bonds versus revenue bonds?
- GO bonds are debt of govt at large & backed by govts full faith and credit
- rev bonds backed only by specific revs from a govts business type activities; bear higher interest rate than GO bonds
- (1) rev bonds, because they are not obligations of govt at large, are usually not subjectto voter approvals or other forms of voter oversight. therefore, they are a means of circumventing constitutional or legislative constraints on GO borrowing.
- (2) by using rev bonds, govt can readily incorporate debt service costs into user fees. facilities financed by rev bonds are paid for out of user chargers, not taxes or other gen revs. costs are shared among constituents of govt, based on benefits they receive rather than on factors on which taxes & other gen revs are based. rev bond financing may be especially apprpriate when parties residing outside of govts property tax jurisdictio are to be the major users of the facilities. parties might otherwise escape paying for the assets.
Definition or arbitrage
issuance of debt at relativey low, tax-exempt rates of interest & the investment of proceeds in taxable securities yielding a higher return
basics of arbitrage
- consequences for cap projects and debt service funds
- if gov were permitted to engage in arbitrage, they could generate virtually unlimited earnings by investing bond proceeds in higher yielding, risk -free fed gov securities. using those securities as collateral for their own bonds, they could ensure that their debt was also risk-free.
- thus, 2 regulations: (1) 1969 rule prohibiting arbitrage with several exceptions (2)1986 rule must remit to fed gov
- if fail to compy with mandates, compromises tax-exempt status of bonds, and subjects itself to bondholder litigation and political embarassment
Definition of overlapping debt
oblitagions of property owners within a particular gov for their proportionate share of debts of other govs with overlapping geographic boundaries
concern: property located in one gov's jurisdiction may serve as the tax base for one or more other govts
principles of bond pricing
debt refundings: if a govt must retire outstanding debt by repurchasing it in open market and paying a price reflective of current interest rates, there is no benefit to refunding. no economic gain, because premium to retire existing bonds exactly offsets PV of future interest savings. THE PV OF BONDS ISSUED AT PAR IS ALWAYS THE SAME AS THEIR FACE VALUE.
bonds issued with call prices: give issuer opportunity to redeem (call) the bonds at a pre-est price, irrespective fo the current market price. most call provisions don't become effective until a specified number of years.
even if call prov is not yet effective, govt can still lock in savings that would result from a decline in prevailing IRs. can do this via in-substance defeasance: an advance refunding in which borrower economically, although not legally, satisifies its existing obligations.
definition of pension
- sums of money paid to retired or disabled empoyees from a pension plan sponsored by their employer or by the state
- pension trust fund--a fidicuiary fund
defnied contribution plan
employer is obligated only to make annual contributions in the amount specified in plan terms. employer records each year an expenditure or expense and red in cash.
defined benefit plan
employer guaratees the outputs (payments to retirees), not the inputs (contributions to pension fund). employer must ensure that it sets aside suff resources each year to make the promised payments when due.
how pension obl is reported?
city's req cont is $80 million to pension fund
city contibutes onyly $75 mill.
- city reports gov fund expenditure of $75 million equal to cash contribution.
- discloses $80 million requirement and an NPO of $5 million in notes, and includes the obligtaion in its schedule of long-term obligations.
in govt wide statements, city reports pension expense of 80 million, and liability (NPO: net pension obligation) to pension plan of $5 mill.
govt should indicate quality of ratings of nvesments in debt securities. should disclose amount of balances that are subject to "custodial" credit risk. if there is a risk that the party will default on its obligations to the gov.
interest rate risk
should disclose info as to how sensitive their investments are to changes in interest rates.
contracts whose values depends on, or derives from value of an underlying asset, reference rate, or index.
why are derivates risky
they embrace many types of securities, ranging from the ordinary to the esoteric. they are highly volatile insturments and can enable investor to achieve gains or cause it to incur losses that are greatly out of proprtion to he cahnge in the value of the seucirites or assets to which they are linked.
basics of nonprofit reporting
- must classify their net assets into 3 categories
- Pemanently restricted: could be restricted by donors, board of directors, endowments
- Temporairly restricted: 2 reasons: time, purpose restrictions
- pledges not enforceable unless acted on already
- all expenses reported as decreases in unrestricted column. trasnfer from rest to unrest. Always 2 sets of journal entries.
issues it faces: ownership, control, and economic interest.
Characteristics of Sound Operational Objectives
- Should represent true ends (outcomes), not means (outputs)
- · Should be readily measurable, yet capture desired outcomes
- · Should be measurable within a period sufficiently short to take corrective action
- · Should be precise· Generally must be multiple
Key Features of Zero-Base (Priority Based) Budgeting
- · Focuses on activities -- the administrative techniques employed to carry-out a program · Requires that both current and proposed activities be subject to the same review and priority ranking
- · Requires the preparation of decision package for each activity that includes:
- --Activity objectives, in terms of both outputs and outcomes that are objective, quantifiable and measurable
- --Alternative means of accomplishing the same objective
- --Consequences of not performing the activity
- --Outputsand outcomes at various levels of funding, including the current level and at least one level that is below the current level
- · Specific inputs for each level of outputs, such as dollar amounts, and number and classification of personnel
- · Promotes the use of proper cost accounting procedures to determine the specific impact that changes in outputs would have on required inputs
- · Encourages funding at "discrete" levels to assure that "slack" is minimized and resource productivity is maximized
- costs that do not vary with volume, fixed only within "relevant range"
- can vary within a relevant range
variable only within relevant range
to select the option that provides the greater net benefit--the marin b/w benefits and costst; those taht differ if one alternative is chosen instead of another.
Allocated costs should be taken into account for most decisions only when they are incremental.
Key issues ¨ Time horizon ¨ Value of assets at conclusion of period of analysis ¨ Discount rate ¨ Alternative uses of resources ¨ Value of overhead reductions ¨ Cost of services after initial contract period
basic principles of capital budgeting
- decision depend on specification of objectives! reduced police patrols, to detering violent crimes, todollar cost per crime. must account for operating expenditures.
- 2 stages:
- first: individual projects are screened to determine whether they should be undertaken at all. compare alternative means of achieving the same objective. selects the most cost-effective. benefitcostanalysis!
- second: ranking the projects that pass through initial screen.
govts and nonprofits shape desitny thru acquisition of cap assets. costly, but have long lives. requires commitment.
issues pertaining to endowment funds
- gains considered expendable income or nonexpendable principal?
- depends on specific donor or legal stipulations
- affects amount of resources available to support endowment's purpose and is likely to influence govt's investment policies
- in accounting for gains to principal//need to protect principal from inflation,
- HOWEVER, perverse consequences of encouraging govts to adopt less than optimal investment strategies
PENSION: factors that increase or decrease value of plan assets
- contributions from employers and ees
- payments of benfits/expenses
- investment earnings and losses
PENSION: factors that increase or decrease actuarial accrued liability
- payments to beneficiaries
- benefits earned by employees in current period
- changes in promised benefits or terms of pension plan that are given retroactive effect
- diff b/w assumptions made in actuarial valuation and actual results
- changes in actuarial assumptions themselves