A company’s capital structure represents its combination of equity and debt finance. Usually, the former includes money collected from shareholders by issuing shares.
These shares may consist of both ordinary and preferred stock. On top of that, equity also consists of retained earnings and other reserves.
This finance source is long-term compared to debt finance. However, it may cause a dilution of ownership.
Debt finance, in contrast, is money collected from third parties. More accurately, it is any financial obligation towards those parties. Those third parties may include suppliers, lenders, and other debt providers.
These parties may provide dedicated finance or credit terms based on their relationship. Furthermore, debt finance usually comes with a specific maturity period. Therefore, it lasts shorter than equity.
For most companies, debt finance may be cheaper. The primary reason includes this finance source not diluting ownership. On top of that, debt finance requires interest payments, usually at a fixed rate.
It is more straightforward to manage these payments than the perpetual payments to shareholders. In most cases, companies use loans for long-term debt finance. However, they may also utilize bonds.
What is a Bond?
A bond is a debt instrument issued by companies to raise finance. It differs from other debt sources in several fundamental aspects. Essentially, a bond is a loan from an investor to a borrower.
However, it does not come from financial institutions in most cases. Instead, it comes from third parties who can buy these instruments in a market. In exchange, they receive interest payments based on a fixed coupon rate.
In most cases, bonds come with a fixed interest rate. It allows the issuer to track and measure the payments on their bonds.
On the other hand, it also offers investors a stable finance source. This interest rate comes from the bond indenture, also known as the coupon rate.
Companies multiply this rate with the bond’s face value to calculate the interest payments.
With bonds, investors lend money to a company or issuer for a set period. The issuer uses the finance in various ways.
In some cases, they may also limit the usage in the bond indenture. However, the issuer usually has no restrictions on the usage of the funds.
Once the bond matures, the investors receive the bond’s face value from the issuer. During the period they hold the bond, they also get interest payments.
Bonds are also tradeable in a dedicated market. In that regard, they are similar to other securities like stocks.
Therefore, companies can not only issue bonds but can also acquire them from other issuers. By doing so, they become investors while holding the bonds.
These bonds usually represent an investment for the company. It may create some confusion on whether bonds are assets or liabilities.
Overall, a bond is a debt instrument companies use to raise capital. These instruments differ from other debt sources such as loans and leases.
Usually, the investors are individuals or other investors who acquire them through a market. In that aspect, bonds are similar to other marketable securities.
Therefore, companies can also purchase them as an investment option.
Are Bonds Assets or Liabilities?
Bonds can be assets or liabilities based on the party that accounts for them. However, it is crucial to understand the definition of both terms.
An asset is a resource owned or controlled by an entity that results in inflows of economic benefits.
This definition allows companies to differentiate between items and record them properly. These resources may include fixed assets, cash, inventory, stock, etc.
In contrast, a liability represents any amount owed to a third party other than shareholders. It refers to obligations from past events that lead to outflows of economic benefits. The latter definition applies to accounting for these items.
Usually, liabilities include loans, leases, account payables, bonds payable, etc. Liabilities are the opposite of assets in accounting terms.
Companies usually issue bonds to investors. Through these bonds, they receive finance. However, it also creates an obligation to repay those investors at a future date. This obligation involves the face value of the bond.
In that regard, a bond is a liability since it represents a payable amount. This amount can be current or non-current based on the bond’s maturity. For the company, these bonds appear on the balance sheet as liabilities.
On the other hand, a bond can also be an asset for the investor. When a company acquires bonds from the market, it provides finance to the issuer. The company must record an asset for that amount on the balance sheet.
Usually, companies obtain bonds for investing purposes. Therefore, they appear in the assets section on the balance sheet.
The current and non-current asset classification depends on the company’s intended use.
Overall, a bond can be an asset or a liability, depending on the party accounting for it. For a company that issues bonds, it is a liability. This liability comes from the obligation to repay the investor at a future date.
On the other hand, companies that acquire a bond record it as an asset. Usually, the former case applies more to companies.
Since most companies use bonds to raise finance, it usually appears as a liability on the balance sheet.
What are the Journal Entries for Bonds?
Bond journal entries differ based on whether companies treat them as assets or liabilities. When a company issues shares, it is obligated to repay the investor.
In this case, the company must record bonds as a liability. This process involves creating a payable account and also increasing the cash resources. The journal entries for the issuance of bonds are as below.
|Cash or bank
However, companies may also acquire bonds as an investment. Although these cases are rare, companies do so as a part of their investment strategy. In this case, the company provides the finance and obtains the bonds in exchange.
Therefore, it must record an asset in the accounts. Companies usually treat these bonds as short-term or fixed-income investments. Nonetheless, the journal entry for the acquisition of bonds is as below.
|Short-term or fixed-income investment
|Cash or bank
In both cases, the bonds will also generate interest payments. In the former circumstance, the bond will create payable interest.
Therefore, it will be an expense for the company. On the other hand, any interest payments on bond investments fall under income for the company. However, these treatments do not impact the bond’s accounting of accounts.
A company, ABC Co., purchases 1,000 bonds with a face value of $100. The company plans to hold these bonds for the income it generates. The maturity date for these bonds falls after five years.
Nonetheless, ABC Co. intends to hold these bonds until that time. ABC Co. acquires these bonds, it pays $100,000 (1,000 bonds x $100) through its bank account. The company records the transaction as follows.
At maturity, ABC Co. receives the bond’s face value from the issuer. In that event, the company removes the asset from its accounts.
Similarly, it also recognizes an increase in its bank account balance. The journal entries for the transaction include the following.
As mentioned, the company must also record any income from the bond through its interest payments.
However, that does not impact the classification of bonds into assets or liabilities. Nonetheless, it is crucial to record those payments as income.
A bond is a debt instrument used by companies to receive finance. Bonds can be assets or liabilities based on the party accounting for them. Usually, companies use bonds to obtain finance.
In that case, bonds are liabilities that give rise to obligations. However, companies may also acquire bonds from the market. In that case, bonds are assets that represent resources owned or controlled by the company.