Agenda - Council - 08/24/1982 - Laserfiche WebLink

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Tt~IE WL'fzK IN REVIEW - 82-3__~._~] Accounting & Reporting July 30, 1982 NCGA STUDIES ACCOUNTING FOR DEBT SECURITIES "SWAPS" The National Council on Governmental Accounting (NCGA) has issued a Discussion Memorandum, Accounting and Financial Reporting for Exchange of Debt Securities by Public Employee Re- tirement Systems and Qther Entities. Some of the principal issues: 'i i i i I I I I I Fixed income securities such as bonds, debentures and mortgages are held in the portfolios of Public Employee Retirement Systems (PERS) and other entities to provide a relatively secure form of investment, yielding a stable income over the term of the investments. Such investments may be sold before maturity and invested in similar fixed income securities, primarily to improve yield. The yield of the security purchased may be better than the one sold because it carries a different maturity date, because the issuer differs (e.g. a taxable bond is purchased with the proceeds from the sale of a tax-exempt bond), because of normal market conditions, etc. This exchange of fixed income securities is often referred to as a "bond swap." Because interest rates have increased since the 1960's (and more rapidly during the past two years), market values of older fixed income securities have declined correspondingly. As a result, the dis- posal of fixed income securities frequently gives rise to a loss, and the simultaneous acquisition of a basically similar fixed income security is accomplished at a discount. An accounting issue is therefore created: Should the loss on the sale of the fixed income security'be recognized immedi- ately (as if it were a completed transaction) or should the loss be deferred and amortized over some longer period of time, such as the life of the bond sold or acquired? Two alternative methods exist in accounting for gains and Io~ses on exchanges of debt securities: Completed Transaction Method--recognizes the gain or loss on sale of debt securities (i.e., the differ- ence between the selling price and book value) at the time of sale. The purchase of another bond with the proceeds is recorded at cost at the time of purchase. The transactions are recognized as separate and each is recorded separately as a sale and as a purchase. The completed transaction method conforms closely to presently accepted principles of accounting. It is based on an estab- lished accounting principle well documented in the professional literature of the AICPA. Deferral and Amortization Method-recognizes a deferred gain or loss at the time of the sale, amor- tizing the deferral over the remaining life of the new (or old) bond. While each transaction is re- corded separately as a sale and purchase, the transaction is considered a "swap"; no gain or loss is recognized at the time of sale because it is to be. amortized, along with any discount or pre- mium on the related purchase, as a charge against future interest income. The basic issue on which opinions and comments are sought is: Should the deferral and amortiza- tion method of ac~:ounting for gains and losses on debt security exchanges be considered as an acceptable alternative to the completed transaction method; or should the NCGA prescribe one of the two methods as the only acceptable method? ! ! Comments on the Discussion Memorandum should be submitted by October 1 to: NCGA Suite 800 180 N. Michi§an Ave. Chicago, Illinois 60601