Debt Accounting: Carrying Value and Interest Expense

Introduction

Intel ended 2024 with about $51 billion of senior notes and other borrowings. It reported interest expense of $1.0 billion. That figure was net of $1.5 billion of interest the company capitalized into the cost of factories it was building, so the interest it actually incurred was roughly two and a half times the amount reported as expense. And its debt note showed bonds whose coupons and effective interest rates differed by several points: notes paying a 3.70% coupon carried an effective rate of 7.49%.

None of this was unusual. Debt accounting starts from a simple idea, that a borrowing is recorded at the amount received and interest is charged over time, but the details decide what interest expense a company reports, what its debt is carried at and how its cash interest compares with both. Where debt appears on the balance sheet, and the difference between face value, carrying value and fair value, is covered in debt on the balance sheet; the question here is how the carrying value and interest expense are measured.

Most corporate debt is measured at amortized cost. The borrowing is recorded at its net proceeds, the cash received less any issuance costs, and its carrying amount is then adjusted each period so that it reaches the face amount at maturity. Under Accounting Standards Codification (ASC) 835-30, interest expense is calculated with the effective interest method: the carrying amount times the rate that exactly discounts the debt's future payments to its initial carrying amount.

Effective interest rate

The rate that discounts a debt instrument's contractual cash flows, principal and interest, to its initial carrying amount. Under the effective interest method, interest expense each period equals the carrying amount at the start of the period times this rate, so any discount, premium or issuance cost is spread over the life of the debt.

When a bond is issued at its face value with no costs, the effective rate equals the coupon and the method is invisible. It matters when the two differ. Suppose a company issues five-year bonds with a face value of $1,000 and a 6% coupon when market rates for its credit are 5%. Investors pay a premium, about $1,043, for the above-market coupon. In the first year, interest expense is about $52, 5% of $1,043, while the coupon paid is $60. The $8 difference reduces the carrying amount to about $1,035, and the process repeats until the carrying amount reaches $1,000 at maturity. Over five years, total interest expense is about $257: the $300 of coupons less the $43 premium. A bond issued at a discount works the other way, with interest expense above the coupon, the case covered in debt issuance costs and original issue discount.

Fixed, Floating and Swapped

The effective rate in a debt note can also reflect hedging. Many companies issue fixed-rate bonds and use interest rate swaps to convert them to floating rates, or the reverse. Under fair value hedge accounting, the carrying amount of the hedged debt is adjusted for changes in its fair value due to interest rates, and interest expense reflects the swapped rate. Intel's note shows both effects: some notes with low coupons carry effective rates several points higher, consistent with fixed payments swapped to floating at a time of high short-term rates, and swaps with a notional amount of $12.0 billion hedge fixed-rate notes now carried at about $11.4 billion, $582 million below their face amount because higher rates reduced their fair value. Hedge mechanics are covered in derivatives and hedge accounting.

The Fair Value Option

US GAAP allows a company to elect to carry debt at fair value instead, under ASC 825, but few nonfinancial companies do. When a company does, changes in the debt's fair value caused by its own credit risk go to other comprehensive income rather than net income, a change made by Accounting Standards Update (ASU) 2016-01 to stop companies reporting gains when their own creditworthiness deteriorated, as Deloitte's summary of the update explains. For almost all industrial companies, fair value appears only in the notes.

When a company borrows while building an asset that takes a substantial period to get ready for use, such as a factory, a ship or a large software system, ASC 835-20 requires part of its interest to be capitalized into the asset's cost. The amount is the interest that could have been avoided had the spending not occurred: the company applies the rate on any specific construction borrowing to the average accumulated spending it funds, and a weighted average rate on its other debt to any spending beyond that borrowing. Capitalization begins when spending, construction activity and interest are all under way, and stops when the asset is substantially complete. It cannot exceed the interest actually incurred.

Capitalized interest

Interest cost incurred during the construction of a qualifying asset that is added to the asset's cost instead of being expensed, under ASC 835-20. It is measured as the interest that would have been avoided without the spending on the asset, and is expensed later through depreciation once the asset is in use.

Capitalized interest does not disappear. It becomes part of the cost of property, plant and equipment (PP&E), as described in PP&E capitalization and cost basis, and reaches the income statement later as depreciation. Intel's 2024 annual report shows how large the effect can be for a company building factories:

The cash flow statement treats the two portions differently as well. Under ASC 230, interest paid and expensed is an operating cash outflow, while the capitalized portion is included in capital expenditures, an investing outflow, which is why Intel discloses cash paid for interest net of capitalized interest. The classification rules are covered in classifying interest, dividends and taxes paid.

Interest expense and cash interest diverge for several reasons. Amortization of discounts and issuance costs adds non-cash expense; amortization of premiums subtracts it. Interest paid in kind (PIK), by adding to the principal rather than paying cash, is expense without any cash outflow, as traced in PIK interest on the three statements. Coupon dates rarely match the reporting period, so accrued interest builds up and is released. And capitalized interest is cash paid that never appears as interest expense at all.

Intel shows how these pieces can offset. Its $987 million of cash paid for interest, net of capitalized interest, sat close to its $1.0 billion of interest expense in 2024, so the two reported lines look consistent with each other. Neither includes the roughly $1.5 billion of interest capitalized into factories, which is carried in capital expenditures once paid. A reader who compares only those two lines misses more than half of the interest the debt incurred.

The debt note brings the pieces together. It lists each instrument with its coupon, effective rate and maturity, shows the unamortized discounts, premiums and issuance costs that bridge face amount to carrying amount, and discloses any hedge adjustments and the fair value of the debt. Read with the interest note and the supplemental cash flow disclosure, it shows what the company owes, what that debt costs in the income statement and what it costs in cash.

Two parts of the note matter most for credit work:

Covenant terms, the conditions under which lenders can accelerate repayment, are usually summarized in the note as well, with a statement of whether the company is in compliance. How bankers turn the note's figures into leverage and coverage measures is covered in leverage and coverage ratios.