An organization may incur a number of costs when it issues debt to investors. For example, when bonds are issued, the issuer will incur accounting, legal, and underwriting costs to do so. The proper accounting for these debt issuance costs is to initially recognize them as an asset, and then charge them to expense over the life of the bonds. The theory behind this treatment is that the issuance costs created a funding benefit for the issuer that will last for a number of years, so the expense should be recognized over that period. For example, if $40,000 of costs are incurred to issue bonds that have a life of 10 years, the $40,000 should be capitalized and then charged to expense (amortized) at the rate of $4,000 per year for the next 10 years.
The mechanics of this accounting is to first debit a debt issuance asset account, such as Debt Issuance Costs, while crediting the accounts payable account to recognize the associated liability. This means that the issuance costs will initially appear on the balance sheet of the issuing entity. Then, at regular intervals, a portion of the asset is charged to expense by debiting the Debt Issuance Costs expense account and crediting the Debt Issuance Costs asset account. Doing so gradually shifts the cost from the balance sheet to the income statement. If the issuer elects to repay its debt early, then the associated debt issuance costs that have not yet been charged to expense are expensed at the same time.
An alternative accounting treatment is to charge all debt issuance costs to expense at once. This option is available when the amount of these costs is so low that they are immaterial to the results stated on the issuer’s income statement.