Accounting Definition of Debt

A debt is a liability that a borrower must repay.

Corporate debts are the lifeblood of modern-day capitalism, providing organizations with the economic fuel and liquidity levels necessary to fund operating activities, engage in corporate expansion programs and run a thriving business. Accountants record debts on corporate balance sheets, signaling to investors and financial analysts an organization's credit risk and operating reliance on borrowed, external funds.

Identification

A debt is a liability that a corporate borrower must repay or a nonfinancial promise it must honor on time. Financial institutions, such as banks, insurance companies and hedge funds, provide funds to organizations, earning interest income and often receiving collateral to secure loans. All types of organizations, including nonprofits, businesses and government institutions rely on external cash to finance operating activities in the short and long terms.

Types

There are two types of debt, based on obligation maturity: short-term and long-term. A short-term debt is a loan that a borrower must repay within 12 months. A long-term liability is due within a period exceeding a year. Examples include accounts and taxes payable (short-term) or bonds payable (long-term).

Considerations

In the corporate context, debt accounting entails financing as well as liability recording and reporting. Organizations typically seek financing through private or public markets. A company accesses private loans by hiring an investment bank, relying on the bank's network of financial institutions to raise funds. Public markets---or financial exchanges---offer relatively cheaper ways of raising cash because these markets enable borrowers to tap a vast pool of investors, say corporate debt experts Peter Gibbard and Ibrahim Stevens. Debt recording requires accounting dexterity. To record a debt transaction, a corporate accountant debits the cash account and credits a liability account. The liability account may be a short-term or long-term account, depending on the debt covenant and maturity. The accounting term of debit is distinct from the banking concept---in accounting terms, debiting cash, an asset account, means increasing the account balance.

Effects

Debt accounting has implications in how companies prepare financial reports. Corporate accountants report debts in the balance sheet, also referred to as the statement of financial position or statement of financial condition. In addition to debts, organizations indicate assets and equity balances in their statements of financial condition, providing insight into their economic soundness.

Misconceptions

Corporate debt is distinct from bad debt, which is a portion of corporate accounts receivable that a company believes it may not recover. Also called doubtful debt, this liability is an important risk management parameter to which top leadership pays attention when charting credit risk strategies, say Andreas Stephan, Oleksandr Talavera and Andriy Tsapin, economics lecturers at European University Viadrina, Aberdeen Business School and Jonkoping International Business School, respectively. To record a bad debt transaction, a corporate accountant debits the bad debt expense account and credits the allowance for doubtful items account.

References

• Investor Glossary: Debt
• U.S. Securities and Exchange Commission: Bonds, Corporate
• Andreas Stephan, Oleksandr Talavera and Andriy Tsapin: Corporate Debt Maturity Choice in Transition Financial Markets
• Peter Gibbard and Ibrahim Stevens: Corporate Debt and Financial Balance Sheet Adjustment: a Comparison of the United States, the United Kingdom, France and Germany