Debt
Recall that in our lemonade stand example, in order to get started, you borrowed some money from a bank. This loan represents debt, which is regarded as one of the two primary sources of funding (capital) for corporations (the other is equity).
Companies with debt obligations are committed to making fixed payments to their lenders. The bank loan in the lemonade stand case requires you to pay regular interest payments (recall interest expense on the income statement) on the borrowed amount, which you must repay at some point in the future.
Suppose you borrowed an additional $100 for your lemonade stand from the bank, which you will need to pay back in 10 years. In the meantime, you must make annual interest payments at a rate of 10%. Here is the impact of the original debt issuance:
| Debit | Credit | |
|---|---|---|
| Cash (A) | $100 | |
| Long-term debt (L) | $100 |
After the first year, you must make your first interest payment. Here is the impact on the financial statements:
| Debit | Credit | |
|---|---|---|
| Interest expense (SE) | $10 | |
| Cash (A) | $10 |