Accounting for Payment in Kind Bond
Payment in kind bond is the type of bond in which interest paid in form of bond instead of cash. It means bondholders will not receive annual interest cash but the increase of bond principal. Bondholders will receive extra bonds as the return from the main bonds. Both principal and interest bonds will be fully paid on the maturity date.
Payment in Kind bond allows the issuer to delay cash outflow which is very important when company facing a liquidity problem. It is a matter of alive or dead when it comes to cash outflow in a critical situation. However, the debt will increase eventually and more cash require to pay to bondholders on the maturity date.
Feature of Payment in Kind Bond
- Unsecure: this kind of bond is not back up by any colleterial, so it is not considered as the security bond.
- Maturity: The minimum maturity is 5 years, the company can issue a longer period bond depend on their term and condition.
- Restricted Refinancing: The issuers are not allowed to refinance bonds in the initial 1-2 year. It will come with a huge premium if they wish to refinance.
- Detachable Warrant: bondholders receive the right to purchase equity shares or bonds at a specific price for a certain period of time.
Advantage of Payment in Kind Bond
- Save on cash flow: The issuer has the option to keep the cash and use it on operation, expanding, and so on. It very important when company has a cash flow problem. By using payment in kind bonds, company can extend the cash outflow.
- Flexibility: It gives enough time for management to prepare cash payment for the investors. They can focus on the operation without worrying about cash outflow during the initial years.
- Good for long-term investment: Some investments require a quite long time before generating cash flow, so this kind of bond is very suitable. The company will be confident enough to wait until the project generates cash flow and pay both interest and principal.
Disadvantage of Payment in Kind Bond
- High credit risk: bondholders will face a high risk of default as the company will face a huge cash outflow at the end of the maturity date. Moreover, the bonds are not backed by any colleterial, so it will increase the chance of default.
- High-interest rate: In order to attract the investors, company needs to increase the interest rate so it will hurt the company in long term. They need to spend a high cost of capital to get into the capital market.