Long-Term Debt and Bonds

Description

Firms can raise capital from shareholders (equity capital) or from lenders (debt capital). One of the fundamental differences between both sources of capital is that debt capital must be repaid in the future whereas equity capital will remain in the firm forever. In addition, debt accrues interest. The firm is legally bound to repay its debt and the interest cost to the debtholders on specific dates but it does not have to return the equity capital to its shareholders. If the firm defaults on its debt repayments, the debtholders can take over the firm to try to recover their money. This note explains how to account for long-term debt. Specifically, the note illustrates accounting for mortgages, loans and bonds. It explains how bonds work and offers an example of bonds issued at par, at a premium and at a discount. The reader will learn the effective interest method to allocate the cost of debt over time. This method is also used for the accounting of capital leases. The note "Leases" can be used to complement this one.

Learning Objective

Firms can raise capital from shareholders (equity capital) or from lenders (debt capital). One of the fundamental differences between both sources of capital is that debt capital must be repaid in the future whereas equity capital will remain in the firm forever. In addition, debt accrues interest. The firm is legally bound to repay its debt and the interest cost to the debtholders on specific dates but it does not have to return the equity capital to its shareholders. If the firm defaults on its debt repayments, the debtholders can take over the firm to try to recover their money. This note explains how to account for long-term debt. Specifically, the note illustrates accounting for mortgages, loans and bonds. It explains how bonds work and offers an example of bonds issued at par, at a premium and at a discount. The reader will learn the effective interest method to allocate the cost of debt over time. This method is also used for the accounting of capital leases. The note "Leases" can be used to complement this one.

Related Documents

• Introduction to Financial Accounting
• Introducción a la contabilidad financiera (IESE)
• The Balance Sheet
• El balance de situación
• The Income Statement
• The Statement of Cash Flows: Direct and Indirect Method
• Accounting for Inventories
• Accounts Receivable Valuation
• Noncurrent Assets
• Liabilities: General Issues
• Shareholders' Equity
• Consolidation
• Consolidación
• Tax Accounting

Keywords

Accounting Financial accounting financial reporting Financial statements