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Debt Issue Costs

Moneyzine Editor
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Moneyzine Editor
3 mins
January 15th, 2024
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Debt Issue Costs

Definition

The term debt issue costs refers to the expenses associated with issuing bonds or notes. These expenses can include underwriting charges, printing costs, and legal and registration fees. Accounting rules require companies to amortize these costs over the term of the associated debt.

Explanation

Issuing long-term bonds represents an important source of financing for many companies. The process of issuing bonds to the public takes a considerable amount of time. Approval is needed from the Securities and Exchange Commission, a prospectus must be written, and underwriting of the securities might be arranged.

When a company issues debt, it can do so in one of two ways:

  • Underwriter Placement: the entire debt issue is sold to an investment bank, who subsequently resells to both the public as well as security dealers. The underwriter will purchase the bonds at a specific price, thereby assuming the risks associated with this debt.

  • Private Placement: the company can also choose to sell the debt issue directly to the public; oftentimes a pension fund or another large institutional investor such as an insurance company. This is a less costly option since it does not require the use of an underwriter or approval of the Securities and Exchange Commission.

With either of the above two options, the company incurs costs such as legal fees, printing expenses, and possibly underwriting and registration fees. Generally Accepted Accounting Principles require companies to create an asset account known as bond issue costs or debt issue costs, and move these costs over the term of the security to the income statement using a corresponding expense account.

Example

Company A issued $10,000,000 in bonds with a coupon rate of 3.5% and a term of twenty years. The Federal Reserve decreased interest rates slightly as Company A prepared the public offering of these securities. For this reason, the bonds were sold at 102, which is 102% of par value. Company A also incurred $40,000 in fees and other charges associated with issuing this debt.

The journal entry to record the issuing of the bonds at a premium would be:

Debit

Credit

Cash ($10,000,000 x 1.02), Less Costs

$10,160,000

Debt Issue Costs

$40,000

Premium on Bonds Payable

$200,000

Bonds Payable

$10,000,000

Note: Cash is recorded as the difference between the amount paid for the securities ($10,200,000) minus the debt issue costs of $40,000.

Using the straight line method, Company A would amortize the premium over a period of twenty years. The journal entry for this transaction is as follows:

Debit

Credit

Premium on Bonds Payable ($200,000 / 20 years)

$10,000

Interest Expense

$10,000

As noted in the above journal entry, selling the bond at a premium effectively decreases the interest expense of the issuing company. Using the straight line method, Company A would amortize the debt issue costs over a period of twenty years. The journal entry for this transaction is as follows:

Debit

Credit

Debt Issue Expense ($40,000 / 20 years)

$2,000

Debt Issue Costs

$2,000

Related Terms

  • Liabilities
    The financial accounting term liability is used to describe the debt of a corporation that results from a transaction involving the transfer of an asset or the provision of a service. Liabilities are reported on a company's balance sheet.
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  • Long-Term Debt
    The financial accounting term long term debt is defined as the loans and other debt obligations of a business that are payable in twelve months or longer. Long term debt appears in the liabilities section of a company's balance sheet.
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  • Interest Expense
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  • Bonds Issued at a Premium
    The term bonds issued at a premium refers to newly issued debt that is sold at a price in excess of its par value. When a bond is issued at a premium, the company will typically choose to amortize the premium paid over the term of the bond using a straight-line method.
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  • Bonds Issued at a Discount
    The term bonds issued at a discount refers to newly issued debt that is sold at a price that is less than its par value. When a bond is issued at a discount, the company will typically choose to amortize the discount over the term of the bond using a straight-line method.
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