Financial Guarantees and Conduit Debt

3 Accounting

3.4 Liabilities

3.4.12 Financial Guarantees and Conduit Debt

Financial guarantees

3.4.12.10 A non-exchange financial guarantee is a guarantee of an obligation of a legally separate entity or individual, including a blended or discretely presented component unit, which requires the guarantor to indemnify a third-party obligation holder under specified conditions.

3.4.12.20 Merely extending a guarantee does not create a financial statement liability for the guarantor. However, when it becomes more likely than not (a likelihood of more than 50 percent) that the guarantor will be required to make payment, a liability should be recorded.

3.4.12.30 When is it more likely than not? This is an assessment based on professional judgment. The government extending the guarantee should consider qualitative factors such as:

• The government that issued the debt has entered into bankruptcy or financial reorganization.
• The government that issued the debt is in violation of related debt covenants such as failure to meet rate covenants, failure to meet coverage ratios, or default or delinquency in interest or principal payments.
• The government that issued the debt has indicators of financial difficulty, such as failure to make payments on a timely basis, drawing on a reserve fund to make debt service payments, initiation of a process to intercept receipts to make debt service payments, debt holder concessions, significant investment losses, loss of a major revenue source, significant increase in noncapital disbursements in relation to operations or current revenues, or commencement of financial supervision by another government, etc.

3.4.12.40 Note: a pledge of future revenues is not considered a non-exchange financial guarantee.

Guarantor accounting

3.4.12.50 When it becomes more likely than not that the guarantor will be required to make a payment, the guarantor should recognize a liability (CR) and expense (DR) in its full-accrual financial statements. The amount recognized should be the discounted present value of the best estimate of the future outflows expected to be incurred as a result of the guarantee. The expense should be classified as a grant or financial assistance to the other entity.

3.4.12.60 In modified-accrual financial statements, the guarantor should recognize the amount currently due and payable. The expense should be classified as a grant or financial assistance to the other entity. The guarantor should not record a receivable for any expected recoveries from the other entity because the likelihood of realization is so uncertain. Recoveries should only be recognized when realized.

Original issuer accounting

3.4.12.70 The government that issued the debt continues to recognize the obligation in its financial statements until it is legally released from the debt.

If the government that issued the debt is required to repay the guarantor for any payments it made on its behalf, the government should reclassify that portion of the original obligation as a payable to the guarantor.

If the government that issued the debt is legally released from the obligation or from any liability to repay the guarantor it should recognize revenue to the extent of the reduction of the liabilities.

Blended component units

3.4.12.80 In order to address the “doubling-up” of liabilities in the financial statements where this situation occurs between a primary government and a blended component unit, the government that issued the debt should recognize in its financial statements a receivable equal to the amount of the liability recognized by the guarantor. The receivable and payable are eliminated at the government-wide level.

Note disclosures

3.4.12.90 For requirements see Note X, Financial Guarantees.

3.4.12.100 For a detailed discussion of the financial guarantees see GASB Statement 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees.

Conduit debt

3.4.12.120 Conduit debt is a debt obligation that bears the government’s name but for which the government issuer assumes no responsibility for payment. Instead the debt proceeds go to a third party who is obligated to make all payments related to the debt. The government issuer and third party cannot be within the same reporting entity. These instruments are issued to help support a third party governmental or nongovernmental entity that pledges to repay the debt.

3.4.12.130 All conduit debt obligations involve the issuer making a limited commitment. Some issuers extend additional commitments or voluntary commitments to support debt service in the event the third party is, or will be, unable to do so.

3.4.12.140 Since the government does not have any obligation for conduit debt, an issuer should not recognize a conduit debt obligation as a liability. However, an issuer should recognize a liability associated with an additional commitment or a voluntary commitment if it is more likely than not (a likelihood of more than 50 percent) the government will make debt service payment.

There may be instances in which an issuer’s additional commitment for each individual conduit debt obligation does not meet the recognition criteria, but when all such commitments are considered in the aggregate, it becomes more likely than not that some additional commitment will be honored. In those situations, the issuer may need to consider the disclosure requirements in paragraph 107 of Statement 62, as amended, when no liability is recognized for a loss contingency.

3.4.12.150 In full-accrual statements, the issuer should recognize a liability (CR) and expense (DR) for the discounted present value of the best estimate of the future outflows expected to be incurred. In modified-accrual financial statements, the government issuer should recognize the amount currently due and payable.

3.4.12.160 If the government recognizes a liability in the financial statements, this also must be reported on the Schedule 09 (Schedule of Liabilities) using the Miscellaneous Liability code 263.99.

3.4.12.170 The issuer should not record a receivable for any expected recoveries from the third party obligor because the likelihood of realization is so uncertain. Recoveries should only be recognized when realized.

Arrangements associated with conduit debt

3.4.12.180 Government issuers may enter into arrangements (often called leases) associated with their conduit debt obligations. There is additional guidance below for arrangements that have all of the following characteristics:

• The conduit debt is to finance construction or acquisition of a capital asset
• The government issuer has title of the asset at the beginning of the arrangements
• The payments from the third party obligor are to cover the debt service payments
• The payment schedule of this arrangement coincides with the debt service payment schedule

3.4.12.190 If the issuer relinquishes the title to the capital asset at the end of the arrangement, the issuer should not recognize a liability for the conduit debt, the capital asset, or a receivable for the related payments.

3.4.12.200 If the issuer retains the title to the capital asset and the third party obligor has exclusive use of the entire capital asset during the arrangement, the issuer should not recognize a liability, the capital asset, or a receivable for the related payments at the beginning of the arrangement. At the end of the arrangement the issuer should recognize the capital asset (DR) at acquisition value and a capital contribution (CR) in the full-accrual financial statements.

3.4.12.210 If the issuer retains the title to the capital asset and the third party obligor has exclusive use of a portion of the capital asset during the arrangement, the issuer should not recognize a liability or a receivable for the related payments at the beginning of the arrangement. In the full-accrual financial statements, the issuer should recognize the entire capital asset (DR) and deferred inflow of resources (CR). The deferred inflow should be reduced (DR) and capital contribution (CR) in a systematic and rational manner over the term of the arrangement.

Note disclosures

3.4.12.220 For requirements see Note X – Long-Term Debt.

3.4.12.230 For a detailed discussion of conduit debt see GASB Statement 91, Conduit Debt Obligations