Question

Journal entries for Debt Service Fund transactions

At the start of 2019, Croton’s Debt Service Fund had no assets or liabilities. Prepare appropriate journal entries to record these transactions in the Debt Service Fund and where appropriate, in the General Fund. (We suggest you post opening balances and the journal entries to general ledger T-accounts.)
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The General Fund transferred $1,200 cash to the Debt Service Fund.
The first installment of principal and interest on the bonds sold in Part C (1) came due for payment.
The principal and interest due for payment were paid.
Debt service on bonds sold by Croton in previous years came due and was paid. Principal and interest payments on those bonds were $600 and $470, respectively.
Note: In the Fund column, select the appropriate fund in which the journal entry is recorded (General Fund: GF or Debt Service Fund: DSF).

Answer 1

An open market purchase by the Fed results in an increase in a bank's reserves and a corresponding decrease in bonds, with no immediate change to equity or deposits unless new loans are made.

Step-by-step explanation:

When the Federal Reserve conducts an open market purchase and buys Treasury bonds from a bank, there will be changes to the bank's balance sheet. In the scenario of Acme Bank, the balance sheet starts with Assets including reserves at 30, bonds at 50, and loans at 50; Liabilities include deposits at 100 and equity at 30. After selling $10 million in bonds to the Fed, Acme's balance sheet will reflect an increase in reserves and a decrease in bonds, with the same total assets.

Here is how the balance sheet would change:

• Assets: Reserves increase by 10 (from 30 to 40) as the bank receives cash for the bonds. Thus, total assets will now be 60.
• The Bonds decrease by 10 (from 50 to 40) since the bank sold the bonds to the Fed.
• The bank may then decide to use the additional reserves to issue new loans, leaving Loans the same or increased if the bank leverages the addition to reserves.

As a result:

• Deposits remain at 100 initially, but could increase if new loans are made and deposited into accounts within the bank.
• Equity remains unchanged at 30.