Debentures, Mortgages and Long-Term Loans

As we saw from the explanation of long-term liabilities, they are liabilities that the firm has which are due in over a year. There are various possibilities for this:-

• Debentures
• Mortgages
• Long-term loans

Debentures

A debenture is a form of borrowing by a firm. It may issue debentures of a fixed value - say £1000 or £5000 - at a certain rate of interest. These debentures may be bought by individuals or by financial institutions. The debentures will have a fixed time period, after which they will be paid back. This may be 5 or 10 years or in some cases even longer. In some cases they carry perks with them. Much of the new number 1 court at Wimbledon was funded by issuing debentures in return for which people get preferential deals on tickets.

They are often attractive because they tend to be a secure investment, and because the interest will have to be paid, whatever the level of profit. This makes them less risky than ordinary shares. For the firm they can be a good way of raising money because they are predictable. It can plan ahead the cash requirement for paying the interest, and knows exactly when they will have to be redeemed.

Mortgages

A mortgage is also a form of long-term loan. However, it will usually tend to be on property or some other fixed asset. It will be what is known as a secured loan. This means that the loan is secured to the asset it was borrowed for. If the money was borrowed, for example, to finance the purchase of a plot of land and the firm fails to make the required loan payments, then the lender can start legal proceedings to repossess the asset. This means that they will then own it, and can sell it to get their money back. Any surplus would of course be returned to the firm.

The rate of interest may be fixed for a period or it may vary with market rates of interest.

Long-term loans

Other long-term loans may, unlike the mortgages, be unsecured loans. This means that the bank or financial institution that lent the money does not have any title over any of the firms assets, and they would have to go through the courts to get any money back. This can prove to be a lengthy and expensive process. An unsecured loan will therefore tend to attract a higher rate of interest then a secured one where the lender is more certain of recovering their money in the event of a problem.

All these long-term liabilities will be shown on a balance sheet and subtracted off the net current assets to give the net assets. They may alternatively be shown as a part of the firm's source of funds in the bottom half of the balance sheet. Where they are shown is simply an accounting convention and does not alter their meaning at all.

Source:
http://www.bized.co.uk/