Difference between bonds and notes

Bonds & Long-Term Notes
There are a good number of ways to create funding when it comes to organizations and businesses of any size. Two of the more common ones, and indeed the ones that will be covered in this brief research report, are long-term notes and bonds. These two forms of capital creation are similar in terms of what they provide for the organization that issues the bonds or notes. However, they are quite different in how they operate and can be sold or otherwise handled after they are issued. The commonalities and differences between these funding devices will be described along with what each of them is in terms of definition and function. While bonds and notes both serve the same basic purpose, they are different in some very important respects.
Analysis
From an accounting standpoint, both bonds and long-term notes are quite similar. One way in which they are basically the same is that they are written promises to pay interest as well as the principal amount borrowed on some future specified date. Another common thread between the two is that both are reported as a liability from an accounting standpoint. Finally, the interest from both instruments are accrued as a current liability. When looking further at the accounting practices and implications of bonds or notes, it is important to know and remember that if a bond or note is going to reach its maturity within a year of the balance sheet date and the payment for such maturity is going to create a reduction in working capital, then this would make it a current liability. If that is not the case because the maturity, and thus the reduction in working capital, happens more than a year from the date of the balance sheet, than that means it is a long-term liability. When it comes to notes in particular, the latter of those two would obviously be the focus of this report alongside the bonds that are also mentioned (Accounting Coach, 2017).
In less of an accounting context, there are a few other things that should be considered. Both of the instruments have a defined maturity date and both have an implied interest rate that is expected to be honored as printed. Both of the instruments are valued based on their present value and the formula that goes into the same. That would include, of course, future interest and the principle cash flows involved. The interest that is yielded from the instrument does tend to vary. Often times, the interest rate is directly linked to the market and its associated rates. Other times, it can be a rate that is otherwise specified and stated per the details and rules surrounding the issued note or bond. The interest rate stated, whatever it may be, is presumed to be the normal market rate for the instrument in question. There are three narrow circumstances where this might be the case. These would include if there is no stated interest rate, the stated interest rate is clearly not within the normal range of reason or if the face amount is “materially” different than the cash sales price of that same instrument. In the event that one or more of those happens to apply, the fair market value of the instrument would be considered to be the value of that note (UTEP, 2017).
There are some situations, it should be noted, that the notes or bonds are not paid all at once. Indeed, there are some situations where there is the use of installments. This is a common practice when the bond or note is being used to finance property or equipment. In such agreements, there can concurrently be the payment of points, not unlike what happens in many mortgages. Each point is a percentage point of what is being borrowed and, like mortgages, serves as a basis to define what the borrowing fees shall be above and beyond the common interest that will be due from the same transaction. When points are involved, they are typically amortized over the life of the loan, which is a bit different than what is seen with mortgages. One very important thing to know about long-term notes and bonds is that there is a secondary market for bonds. Indeed, a person that buys a bond can sell the bond based on the present value and/or what another party is willing to pay. By contrast, this is not true when it comes to long-term notes (UTEP, 2017).
When it is not immediately clear whether an instrument example is a note or a bond, one can typically figure it out by looking at the details of the arrangement. As noted above, looking at the differences is where you can decipher which one an instrument happens to be. Indeed, securities laws and regulations consider and treat notes and bonds in a different way. Bonds are always regulated as securities, with no exceptions. Those laws, for example, define mortgage notes, commercial paper and short-term notes as not being securities, thus the rules are different. Other notes payable, including long-term notes, may be securities but that depends on the particulars. If a debt instrument is less than a year, it will almost always be a note. If the instrument has a long duration and shelf-life, it is usually a bond. The Treasury of the United States government and how they handle debt is a good example, Indeed, they have both notes and bonds that they sell. A note will typically have a life span of between one year and ten years. By contrast, savings bonds have a lifespan of more than ten years. Even further, anything with less than a year lifespan would be a bill and not a note or a bond. In many to most situations, the differences there are often arbitrary except when it comes to accounting rules. However, there can be situations where these distinctions matter greatly. A few roles and jobs where these differences could matter a great deal would include lawyers, professional debt-traders and securities regulators (Motley Fool, 2017).
Lastly, one should define the clear demarcation point that does exist when it comes to long-term notes versus bonds. Indeed, notes payable are maintained via an account by the business owner. These are considered to be among the long-term liabilities of a firm. Those liabilities are tracked and handled in a way that indicates that a loan is being taken out to fund development of a business, research or to fund regular daily business operations when funds and resources are tight. When speaking of notes, these are generally done when the needed amount is lower than is commonly seen when issuing a bond. By contrast, bonds are long-term debt relates more to the relationship that a business owner has with his/her investors and the overall need is much larger in scale. Indeed, a smaller need would normally involve a loan or line of credit. When the amount of credit being offered is not enough to cover what is needed, this is where a bond would come in. The issuance of such bonds typically has to be done with the facilitation and help of an investment banker. The overall numbers of bonds are done in rather large quantities. A typical amount for such bonds is around $5000. The person with the money extends the $5000 to the firm who needs the money and the later result is that person getting that $5000 along with the associated interest rate, which would be based on the market rate or what is defined with the bond issuance. Regardless of whether bonds or notes are used, they are both investments and they are both a form of investment, or at least a way to handle funding challenges and needs. Regardless of whether it is notes or bonds that are in question, they are both a way to raise capital in a way that would not be possible given just the resources of the business (
Conclusion
Even with the fact that bonds and notes serve the same general purpose and are both recorded in much the same way from an accounting standpoint, it is important to remember that they are quite different in a lot of instances in terms of their size, scope, purpose and functionality. Which one would or could be used in a given instance will depend on the time horizon, business and purposes for the money that are in question.
References
Accounting Coach. (2017). What is the difference between a note payable and a bond payable? | Accounting Coach. AccountingCoach.com. Retrieved 18 August 2017, from https://www.accountingcoach.com/blog/note-payable-bond-payable
Lewis, J. (2017). What Is the Main Difference Between Notes Payable & Bonds Payable?. smallbusiness.chron.com. Retrieved 18 August 2017, from http://smallbusiness.chron.com/main-difference-between-notes-payable-bonds-payable-36843.html
Motley Fool. (2017). What Is the Difference Between a Bond vs. Note Payable? -- The Motley Fool. The Motley Fool. Retrieved 18 August 2017, from https://www.fool.com/knowledge-center/bond-vs-note-payable.aspx
UTEP. (2017). Bonds and Long-Term Notes. University of Texas at El Paso. Retrieved 18 August 2017, from http://accounting.utep.edu/sglandon/c14/c14b.pdf