Accounting for Bonds
To finance the purchase of assets, corporations can raise investment capital in one of two ways: debt or equity. If a company’s management decides to raise debt capital they can borrow from either a financial institution, such as HSBC or Citigroup, or by issuing bonds through the capital markets.
Bonds (sometimes called “notes”) are normally sold to the public through a third party (“underwriter”), e.g., an investment bank. Bonds are interest-bearing notes that involve contractual commitments requiring the issuing company to make cash interest payments to the bondholder and a principal payment when the bond matures. The maturity date is usually between 1 and 30 years from the date of the issuance. After issuance, bonds are freely negotiable; that is, they can be purchased and sold in the open market.
In this chapter, we focus on corporate bonds, drawing on the example of SAP AG (the parent company of the SAP Group) and a fictional competitor, BriteSoft Ltd. (The topic of convertible bonds – bonds that are convertible into shares of common stock – will be covered in the chapter on shareholders’ equity.)
In 2010, SAP issued bonds in the capital markets. To accomplish this sale it hired a consortium of investment banks, and produced a prospectus which describes the terms of the notes. The prospectus reveals the underwriters involved, and the fees charged to SAP (see Box 12.1).
In addition, a pricing notice (Table 12.1) was published, dated ...