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Debt Issuance Costs

Debt Issuance Costs

The debt that is borrowed by a business or an individual is principally charged with two types of debt issuance costs, namely, interest rates and closing costs which sometimes are also known as extra costs.
Scholasticus K
The term debt issuance is also known as cost of capital, or cost of debt or loan. Basically the term originates from the act of raising capital from various sources and cost incurred therein. Micro-economists such as Adam Smith advocated that wealth flows from one source to another by the way of payment to the factors of production.

The four factors of production, being land, labor, capital and enterprise, receive, rent, wages, interest and profits respectively, for their participation in the process of production.

About Debt Issuance Costs

From a layman's point of view, costs of debt issuance, or as some may put it, cost of capital, is basically an expenditure that is incurred as a consequence of borrowing. In modern economics, money is basically treated as a commodity the use of which is charged with money. Thus basically you are renting out money for a specified interest or cost, this cost is generically termed as cost of debt issuance.

For the sake of explanation, let us consider the capital raising process of businesses. Businesses raise their capital from 2 major sources, namely, from stock capital or from debt loans. Here's how the entire transaction goes:
  • The companies issue a specified debt instrument, which is also often termed as a security, against an investment, in order to raise capital. Instead of shares, often bonds, promissory notes and debentures are also issued.

    In such a case, a dividend is paid as the debt issuance cost against the capital borrowed. This premium is paid on a yearly basis, out of profits to all stakeholders.
  • The second type of debt is of course the loan. The debt costs of loans, consists of interest and closing costs which are sometimes also known as origination fees. The interest is paid for a prolonged time, as opposed to the closing costs that are paid in a single installment.
Treatment of Debt Issuance

During financial planning and accounting, debt costs are treated in a different manner. The following are some of the common conventions and standards that are followed by the people and business to treat debt issuance.
  • Accounting considers all debt related costs to be long term expenditures and just like interest costs, the closing and one time costs are also treated as long term expenditures.
  • The debt cost amortization is a process where all cost relating to issuance of debt are phased out over a few years time. In such a case if the closing costs, amount to $5,000 for a loan of 5 years then $1000 is paid every year, or the company accounts are adjusted accordingly. In such cases, this accounting treatment is also termed to be deferred debt costs.
  • The issuance costs tax treatment is different and, as per the Internal Revenue Service (IRS), most of the issuance costs are tax-free, especially the interest.
The debt issuance costs often depend upon the standing of the credit ratings of the individual or business, especially the costs that are incurred during the loan borrowing. Hence, make sure that you improve those before applying for a loan. Share-related costs are however quite less and are aimed at profit-sharing, though in some cases companies opt not to issue a dividend.