Issuance costs, also known as flotation costs, are the expenses that a company incurs when it issues new securities. Companies incur these costs to raise additional equity or debt capital. The expenses can include things like underwriting fees, legal fees, registration fees, and more.
Typically, these costs fall into two main categories:
- Underwriting Fees: These are the fees paid to investment banks or other financial intermediaries for their services in the issuance process. The underwriters help the company determine the offering price of the securities, file the necessary documents with regulatory bodies, and assist in selling the securities to investors.
- Legal and Accounting Fees: Companies have to hire legal and accounting firms to ensure that the issuance process is done correctly and in compliance with all relevant laws and regulations. These firms help the company prepare the prospectus, ensure compliance with securities laws, audit the company’s financial statements, and more.
It’s also worth noting that issuance costs are capitalized and recorded as a reduction of the proceeds from the sale of the security on the balance sheet. Over time, these costs may be amortized (for debt issuance costs) or left unamortized (for equity issuance costs), depending on the type of security and the accounting standards being followed. As of my knowledge cutoff in September 2021, under U.S. GAAP, debt issuance costs are typically amortized over the life of the debt, while equity issuance costs are not amortized.
Example of Issuance Costs
Let’s imagine a company called ABC Corp. that decides to issue bonds to raise capital for expanding its operations. Here’s a simplified example:
ABC Corp. plans to issue $1,000,000 worth of bonds. To do this, they enlist the help of an investment bank, which acts as an underwriter for the issuance. The bank charges a 2% underwriting fee. This means ABC Corp. will pay the bank $20,000 ($1,000,000 * 0.02).
ABC Corp. also hires a law firm to ensure legal compliance in the issuance process and an accounting firm to audit its financial statements. The law firm charges $10,000, and the accounting firm charges $5,000.
Therefore, the total issuance costs for ABC Corp. are $35,000 ($20,000 underwriting fee + $10,000 legal fee + $5,000 accounting fee).
On its balance sheet, ABC Corp. will record the bond liability as the net amount, which is $965,000 ($1,000,000 proceeds from the bond issuance – $35,000 issuance costs). The $35,000 issuance costs are then typically amortized over the life of the bond in accordance with U.S. GAAP.
This example simplifies a complex process, but it shows the basic principle of how issuance costs work and how they are accounted for.