Debt vs Equity
There are two basic ways of financing for a business: Debt financing and equity financing. Debt financing is defined as 'borrowing money that is to be repaid over a period of time, usually with interest" (Financing Basics, 1). The lender does not gain any ownership in the business that is borrowing. Equity financing is described as "an exchange of money for a share of business ownership" (Financing Basics, 1). This form of financing allows the business to obtain funds without having to repay a specific amount of money at any particular time. There are also a few different instruments that could be defined as either debt or equity. One such instrument is stock options that an employee can exercise after so many years with the company. Either using the debt or equity method, or a combination of the two methods can be used to account for stock options or other instruments with the similar characteristics. There are pros and cons to deciding to use either of these methods. First I will discuss the pros of using the debt or equity methods. One pro of using the debt method is that it "does not entail 'selling' their equity, but instead works by 'borrowing' against it" (Financing Using, 1). So the company could account for
Or should they account for it as both? A negative aspect of this method is how the instrument is split between debt and equity. An example would be if the company split an instrument 50/50 between the two methods. This may seem fair when first accounting for it, but what if the split did not represent the actual split of the instrument. Let's say that it turns out that 90% of the instrument ends up being equity, and 10% ends up debt. The books would be off by quite a bit, and creditors my not be happy with the company when they learn of this. ------------------------------------------------------------------------ First I will explain the debt or equity method. This is quite simple. The hard part comes when deciding which method of the two to use. A good way to decide this is to figure out if most stock options become debt or equity. Once the method is decided the business can account for it. They must decide if, like in the 100 shares example above, they want to account for 20 shares or all of it at once. Say the company decides to account for 20 shares a year, the shares are at $25 after an employee's first year, and they are using the debt method. The journal entry for this is shown below:
Some common words found in the essay are:
Financing Basics, Common Shares, Accounts Payable, Financing Using, , debt equity, stock options, accounts payable, Intangible Asset, equity method, common shares, debt equity methods, financing basics 1, equity methods, employee takes, financing basics, pros cons, basics 1, debt equity method, instrument stock options, below journal entries,
Approximate Word count = 1320
Approximate Pages = 5 (250 words per page double spaced)
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