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Definition of Debt in Covenant Accounting

Definition of Debt in Covenant Accounting thumbnail
Debt convenants are contracts limiting what the borrower can do when taking on debt.

Debt covenants are contractual agreements that must be followed to avoid penalties written into the debt covenant. Debt covenants can place restrictions on whether or not new debt can be incurred. Debt covenants may place limits on acceptable debt ratios or require prior approval before more debt financing is allowed.

  1. Loans

    Bonds

    • Bonds are often registered securities, and they can be regulated by covenant agreements.
      Bonds are often registered securities, and they can be regulated by covenant agreements.

      Debt covenants can also cover debt issuance via corporate bonds. The book "Business" by William Pride, Robert Hughes, and Jack Kapoor classifies the primary types of corporate bond debt as convertible, debentured, and mortgaged. Convertible bonds can be exchanged for company stock. Debentured bonds are unsecured and only backed by the company's reputation. Mortgaged bonds are secured by the company's assets.

    Penalties for Breaking Debt Covenants

    • Debt covenants can place limits on dividends paid to stockholders or on corporate board salaries until the debt has been repaid. Debt covenants can include penalties such as higher interest rates or financial penalties that go into effect if debt payments are missed. Breaking conditions of a debt covenant can also make the full debt come due immediately, requiring new financing to pay off the old debt.

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