Which statement about the defeasance of debt is accurate?

Defeasance of debt refers to the process of removing a debt liability from an entity's balance sheet by setting aside funds in a trust or investment account specifically to pay off the debt. This can be particularly significant in accounting and financial reporting as it impacts how liabilities are recorded and recognized.

The accurate statement points out that debt may be defeased both legally and in substance in the public sector. In the public sector, legal defeasance involves the formal release of the debt obligation through legal means, while in-substance defeasance refers to the economic reality of the obligation being effectively removed from the balance sheet, even if formal legal processes have not been completed.

In many public sector scenarios, entities will establish a trust that holds sufficient assets to cover the debt service payments, thereby relieving themselves of the liability on their financial statements. This treatment can aid public entities in managing their financial positions and can also reflect a more accurate portrayal of their current liabilities to stakeholders.

Recognizing that defeasance can occur both legally and in practice is especially relevant for public entities, who often deal with specific regulations and reporting standards that allow for this kind of reporting treatment. The uniqueness of the public sector environment can lead to more opportunities for such arrangements compared to private sector contexts