Why are debt issue costs classified as an asset?
Debt issue costs are classified as assets because of the matching principle. The idea is to match the cost of issuing debt to the periods that benefit from the debt. For example, if a corporation incurs $500,000 of issue costs associated with its 10 year bonds, it should expense $50,000 per year ($500,000 divided by 10 years).
To achieve the matching principle, the corporation must initially defer the issue costs. Deferred expenses or deferred costs or prepaid costs are reported as assets on the balance sheet. In the bond example above, at the time that the corporation pays for its bond issue costs, it will debit Deferred Issue Costs for $500,000 and will credit Cash for $500,000. Then in each of the 10 years of the bond’s life it will credit Deferred Issue Costs for $50,000 and will debit Bond Issue Costs Expense for $50,000.
If the amount of the bond issue costs is not significant, the materiality concept allows the corporation to expense the entire amount of issue costs at the time that the bonds are issued.
Learn more about Bonds Payable.
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While the appeal to the matching principle is true, there are much simpler ways to look at it.
It’s a prepaid expense. You paid it all up front, but are going to write it off amortized over 10 years. Thus, you have an asset of “prepaid issue costs”, which is decreased by 10% each year.
It can also be looked at as a capital good that is amortized over time. Again, you bought it up front, but carry it on the books as a depreciating asset for the lifetime of the bond.
You match the depreciation interval to the bond lifetime so that when you need to roll the bond over in 10 years, you have a steady predictable expense rather than having bond issue expenses suddenly jump from zero to huge.