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| LO4 – Explain, calculate, and record non-current debt. |
A corporation often incurs long-term debt to acquire property, plant, and equipment. These borrowing are repayable over many years. There are three main types of non-current borrowings:
- Bonds pay only interest at regular intervals to bondholders. The original investment is repaid to bondholders when the bond matures (or comes due), usually after a number of years. Bonds issued by a company are generally purchased by many investors, including individuals, financial institutions, and other corporations. Bonds are discussed in detail in a later chapter.
- Loans are also sums of money lent for interest. They differ from bonds in that they are repaid in equal payments on a regular basis, often monthly. The repayments usually consist of both interestand principal paid to creditors. Such payments are said to be blended. That is, each payment contains repayment of a certain amount of the original amount of the loan (the principal), as well as interest on the remaining principal balance. Loans are usually received from only one or a small number of financial institutions. After obtaining a loan, a company often purchases long-lived assets from a third party with the cash proceeds. The loan in turn may be secured by these purchased assets to reduce the risk of non-repayment to the lender. If the loan is not repaid, the lender can seize and legally sell the secured assets, and retain the funds owed to it. For instance a mortgage is a loan secured by specified real estate of the company, usually land with buildings on it.
- A finance lease is similar to a loan in that a series of cash payments are also made over a specified period of time. However, these are not quite the same as repayment of a bank loan. Instead of payments to the bank, the payments are made to a leasing company, called the lessor. The payments give the lessee (the company making the payments) the right to use a long-lived asset owned by the leasing company for a specified period of time. Unlike a short-term rental agreement, the amount of the payments is so large as a percentage of the value of the related long-lived asset and the period of time over which they are made is so long that the lessee in effect purchases the asset, even though legal title may not be transferred from the leasing company to the lessee.
Non-current loans and finance leases are discussed further below.
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