Accounting Considerations for Senior Debt
Service2Client

What is Senior DebtAlso known as a Senior Note, Senior Debt consists of a company’s outstanding loans collateralized by the business’ assets. As the name implies, Senior Debt holders are the first claimants of the business’ cash flows and/or liquidated assets if that business defaults on its debt and files for bankruptcy. Subordinated or junior debt in the form of Preferred and Common Equity shares has claims to any subsequent assets – but only after Senior Debt holders are made whole. 

Originating via financial institutions, revolving credit facilities, and Senior Term Debt are the primary ways companies obtain financing. Whether the debt is funded by another business, an individual backer, or a traditional bank lender, if the borrowing company files for bankruptcy and liquidates its assets, Senior Bondholders are first in line for available repayment.

Senior Debt Characteristics and Structure

Much like any type of borrowed money, each tier has different interest rates and amortization schedules, including Senior Debt. Senior Debt issuers put terms in the debenture restricting companies from issuing additional, lower-tier debt. Debt issuers often require borrowers to maintain specific credit profiles, which are determined by financing ratios such as interest service coverage and debt service coverage.

Other stipulations may include requiring the borrower to maintain or refrain from business activities beyond their essential commercial functions. If the stipulations are flouted, the lender may retract, modify the borrowing terms, or mandate immediate payment of accrued interest and principal. It’s important to note that since Senior Debt has more restrictive terms, interest rates are generally lower compared to unsecured/less senior debt.

When it comes to unsecured debt, primarily junior or subordinated debt, although it’s not collateralized, the terms stipulate that the lender(s) have a claim to the company’s assets in case of bankruptcy/liquidation and are next in line to get paid off from the assets of the company, minus any pledged assets for secured debt debtholders.

Accounting Considerations

The first step to account for Senior Debt is to break it up into short-term and long-term debt (within 12 months and longer than 12 months). For example, long-term debt, which turns into long-term liabilities from short-term obligations, like accounts payable, is recorded on the company’s balance sheet. This generally happens when the short-term obligations are re-classified into a lengthier note.

If a business obtains a $10 million bank loan, secured by their machinery and other assets, for a new product line, with a 7 percent interest rate for 15 years, along with the business assets, liabilities and shareholders’ equity, the long-term portion would be reported on the company’s balance sheet. It would be recorded as a liability on the balance sheet, where any other long-term debt and bonds issued or borrowed by the company.

The income statement would document its loan interest. It’s calculated by taking the principal multiplied by the interest rate.  Once the interest is determined, it’s classified as an expense on the income statement, lowering the company’s net income and profits. As the loan’s principal is paid over the 15-year loan life, a set amount of the loan principal is repaid each year.

Conclusion

Senior Debt can be an effective way to obtain funding, but businesses must understand how funding agreements work and how to properly account for them.

 

Have any questions, give us a call here at Metro Tax & Financial Services.
We are here to help you get through the stress of taxes!

We offer a free 30-minute consultation so call us and let’s get your appointment set up (928) 680-1444

For more Tax Facts make sure you are following us on Facebook

Click HERE for more Tax Facts and Financial News

Suggested Articles

Tax Fact: SBA Loans for suffering businesses

COVID-19 has caused such havoc in our Great Nation. With the request for us to quarantine and for businesses to close down temporarily or cut back on their hours, it has caused a huge amount of stress on business owners and employees. The U.S. Small Business...

CFOs: Keep Your Company in Balance

Chief Financial Officers (CFO’s) keep the company in balance. We previously discussed their roles for business management, which included budgeting, financial forecasting, and keeping the business profitable. Report managing encompasses all of the business management...

Tax Fact: How to Lower your 2019 Tax Bill

Even though 2019 may be over, there are still a few things you can do to lower your 2019 tax bill, if you have a little cash on hand. You cannot make any more contributions to your 401(k) for last year, but you can still make IRA and Health Savings Account (HSA)...

Understanding the Equity Multiplier

Whether you are an investor, an owner, or an internal financial analyst, understanding how the equity multiplier works and how to interpret it is a helpful skill.Defining the Equity MultiplierThe equity multiplier is a metric that tells the user what percentage of the...

Social Security Updates 2025

We were talking about Medicare Changes for 2025 but let's continue and talk about Social Security Updates for 2025 Moving along with the changes for 2025 are the Social Security benefit changes. This change affects those who are on Supplemental Security Income (SSI)...

Tax Needs: Startup Businesses

StartUp Business Photo by Jud Mackrill on Unsplash Entrepreneurs across America believe in the beauty of starting their own businesses. However, the startup and the taxes often cause people to stop in their tracks. Don’t fret! We want you to excel and...

Taxes 2025

This year, 2025, tax day is April 15th. Individuals can file for an extension until October 15th. However, businesses are more likely to file for extensions, as they have more to keep track of throughout the year. As always, whether individual filer or a business...

Startup Businesses: Expenses

Expenses Photo by Domenico Loia on Unsplash Many startup businesses can deduct expenses that were necessary for the business coming to life. Last time we talked about all the tax needs a startup business will need, but let's talk about business expenses. Things like a...

Medicare Changes 2025

We sure hope this year is filled with blessings and wonderful opportunities. That being said, let’s roll right into some changes with this new year. As the cost of living has increased these last few years, the government is making a few adjustments. Let’s discuss the...

Tact Fact: Hobby Versus Business

Imagine if you could turn your favorite leisure activity into a successful business venture. Many Americans are now turning to what they love to earn income, whether it’s enough to quit their day job or just a fun way to cover the costs. If you are passionate about a...
Google
4.7
★★★★★
69 reviews