The fields of law, accounting and valuation continue to grow ever-more complex. Given the overlap in these specialty areas, it is increasingly important for attorneys to understand the accounting, tax and valuation effects of the legal agreements they draft. Armed with this knowledge, attorneys can deliver intended outcomes for their clients and minimize unintentional consequences and compliance burdens. If you would like to download our full eBook, which includes all of the blogs in this series, you can do so here.
In this installment of our Drafting Considerations for Attorneys blog series, we highlight specific considerations around debt issuance and non-interest-bearing debt.
Standard debt issuances (in which a certain amount is borrowed with a stated interest rate for a specific term) typically do not have any unique valuation considerations. However, non-traditional debt issuances, such as non-interest-bearing debt, debt issued with warrants and convertible debt, have unique valuation and accounting issues that must be addressed.
A debt discount is an accounting concept that reflects the difference between the cash proceeds/fair value of a liability and the face amount (total repayment required upon maturity) of the liability. Debt discounts are often recorded when non-interest-bearing debt, debt with warrants or convertible debt is issued. The debt discount is required to be amortized as interest expense over the life of the liability, which increases the liability’s effective interest rate.
A non-interest-bearing debt agreement (such as a note or deferred payment with no stated interest rate) may require a debt discount to be recorded. Just because there is no stated interest rate on a note, it does not mean that interest income/expense will not be recognized. In that case, interest is imputed based on the following rates for book/tax purposes, and a debt discount is recorded to reflect the amount of imputed interest:
- GAAP – interest rates for comparable debt used
- Tax – AFR rates used
Our E-book, Valuation Considerations When Buying or Selling a Business – Part 2, includes all of the blogs in this series. We invite you to download it here.