Accounting theory and practice, Volume 2 (of 3) : a textbook for colleges and…

FIXED LIABILITIES—BONDS AND MORTGAGES Nature of Fixed Liabilities Fixed liabilities, called also capital, bonded, long-term, and funded liabilities or debts, comprise all debts of which the date of maturity is some distance ahead and considerably longer than that of current liabilities. Government regulating boards, for purposes of standardization, may set a minimum life-period for this group of liabilities and any kind of debt falling within the period is so classified. Thus, the Public Service Commission for the First District of the State of New York says: “Funded debt comprises all debt which by the terms of its creation does not mature until more than one year after date of creation.” Private undertakings do not need such exact uniformity. Any debt the maturity of which extends beyond the period adopted within that business for current liabilities will usually be grouped with the fixed liabilities, there seldom being an intermediate group. Purpose of Fixed Liabilities Fixed liabilities, as distinguished from current, are those issued distinctively for the purpose of raising capital. Due to insufficient original capitalization, funds may be needed for one or more of many purposes. Working capital may be required; extensions of plant and market may be desirable; additional equipment and improvement within the plant itself may be advisable; the control of the plant of a competitor may prove advantageous; it may be deemed wise to fund floating liabilities; the refunding of liabilities soon to mature may become necessary; the financial policy may dictate the unification of several diverse forms of debt—these and other purposes may be served by the assumption of long-term debts. Corporation Bonds The most common type of fixed liability is the bond. As an instrument of credit the bond is limited almost exclusively to corporations. The purchasing public, interested in securities of this kind, looks with suspicion on a long-term promise to pay issued by either a single proprietor or by a partnership. Such businesses are almost wholly dependent on the health and ability of individual owners. During a long period of years so many contingencies may arise and seriously cripple the business that the long-term debts of a partnership or sole ownership have no market, although isolated instances of such issues exist. The corporation, however, has continuity of life, is not so dependent on individuals, and therefore has avenues for the raising of funds open to it which are closed to other types of organization. Nature of Bonds A bond may be defined as an instrument under seal promising to pay a certain amount of money at a definite or determinable future time. From a legal standpoint, a bond is a contract setting forth the terms and conditions under which the obligation is assumed. Furthermore, it is a negotiable contract transferable from hand to hand, though in some cases registration is necessary to prove ownership in the eyes of the issuing corporation. From a financial standpoint, a bond is essentially a long-term promissory note. Bonds, as here used, are to be distinguished from the old real estate bond and mortgage. Bonds are usually secured by a lien on some definite property or prospect of property, just as the real estate bond and mortgage. The corporation bond, however, is a separate instrument, divisible into small parts, whereas the bond and mortgage is not usually an instrument of that type. Corporation bonds are also to be distinguished from the surety bonds mentioned in the preceding chapter. These latter, as already noted, are instruments whereby individuals, firms, or corporations bind themselves as guarantors for the conduct of others or for the payment of sums of money for which the guarantor is not directly liable. Difference between Bond and Real Estate Mortgages With regard to the mortgage covering the bond issue, points of difference from the ordinary real estate mortgage are to be noted. To the ordinary mortgage there are two parties, viz., the party obligated and the party accommodated, the obligor and obligee. To the bond mortgage, the obligee is a trustee standing in the stead of the numerous bondholders who could not conveniently act individually. In this trustee the title to the property liened is vested for the benefit of the bondholders. The mortgage instrument itself is often a model of completeness and comprehensiveness, defining with minute care the relations, duties, rights, interests, and status of the issuing corporation, the bondholders, and the trustee under present circumstances and all possible future contingencies. Kinds of Corporation Bonds Since bonds were first issued, perhaps one hundred different kinds have been placed on the market. They all have the same fundamental characteristics but differ in minor particulars. No universally recognized basis exists for their classification, nor is such a basis possible, the use which they are to serve determining always the basis of analysis into classes. Thus, in the opinion of a leading authority[50] on the subject bonds may be classified under the following heads, according to: