Definition of “Debt” in Accounting
Debt refers to an amount of money that is owed by one entity to another under agreed-upon terms. In most commercial transactions, debts are typically expected to be settled within one month of receiving an invoice, failing which interest may accrue. Debt can take many forms, including long-term debt covered by a bill of exchange, which is a negotiable instrument.
Examples of Debt
- Short-term Debt: A company might owe $50,000 on a 30-day invoice for raw materials purchased for production.
- Long-term Debt: A corporation may issue a bond worth $1 million that is payable in 10 years, with interest paid semi-annually.
- Consumer Debt: An individual might incur a debt by taking out a $200,000 mortgage to buy a house, which requires monthly payments over 30 years.
- Government Debt: A government may owe $500 million in treasury bills that it must pay within a year.
Frequently Asked Questions (FAQs)
What are the types of debt?
There are several types of debt including:
- Secured Debt: Backed by collateral (e.g., a mortgage).
- Unsecured Debt: Not backed by collateral (e.g., credit card debt).
- Revolving Debt: Debt that is renewed as it is paid off (e.g., credit cards).
- Installment Debt: Repaid with regular payments over a period of time (e.g., car loans).
What is the difference between short-term and long-term debt?
Short-term debt is typically due within one year, while long-term debt extends beyond one year.
How does debt impact credit scores?
Accumulating high levels of debt can lower credit scores, but managing debt responsibly by making timely payments can improve credit scores.
What is the cost of debt?
The cost of debt refers to the effective rate that a company pays on its borrowed funds, often represented as an interest rate.
Can interest accrued on debt be tax-deductible?
Interest on certain types of debt, such as mortgages and student loans, can be deductible on taxes.
Related Terms
Interest: The cost paid by a borrower to a lender for the use of borrowed funds, usually expressed as an annual percentage rate (APR).
Bill of Exchange: A written, unconditional order by one party to another to pay a specified sum either immediately or on a fixed date.
Negotiable Instrument: A signed document promising a sum of payment to a specified person or the assignee, which can be transferred to others.
Debenture: A type of debt instrument that is not backed by collateral and is only backed by the general creditworthiness and reputation of the issuer.
Loan Capital: The portion of a company’s capital that is financed through long-term loans.
Bond: A fixed income instrument that represents a loan made by an investor to a borrower, typically corporate or governmental.
Promissory Note: A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on demand or at a specified future date.
Online Resources
Suggested Books for Further Studies
- “Debt: The First 5,000 Years” by David Graeber - An anthropological and historical exploration of debt and its impacts on society.
- “The Total Money Makeover” by Dave Ramsey - A guide to getting out of debt and achieving financial stability.
- “Rich Dad’s Guide to Investing” by Robert T. Kiyosaki - Insights into leveraging debt as part of investment strategies.
Accounting Basics: “Debt” Fundamentals Quiz
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