When the debt service fund makes a payment of principal and interest on an outstanding long-term debt, the governmental activities accounts:

• A. Reflect both principal and interest payments.
• B. Reflect only principal payments.
• C. Reflect only interest payments.
• D. Show no effect.

Answer: (A)

When debt service payments are made on long-term debt, the governmental activities records reflect both parts of the payment. The principal portion reduces the outstanding long-term liability, while the interest portion is recognized as an interest expense in the government-wide statements. The debt service fund’s outlay affects cash in the fund, but, in the government-wide view, the important effects are the decrease in the debt balance and the recording of interest cost. This is why both principal and interest are shown in the governmental activities accounts. If only one part were reflected, or if there were no effect, the financial statements would not accurately represent the liability reduction and the cost of borrowing.