Bonds and notes payable both act as different varieties of loan. However, the two financial instruments act in different ways, and may receive different treatments under federal securities laws. Those with specific questions about the differences between bonds and notes should consult a financial or investment professional.
How Bonds Work
A bond is created when an investor loans money to a company, government or other organization. In return for the loan, the investor gains a right to eventual repayment. In a typical bond, the entity issuing the bond must pay back the entire principal at a certain date, chosen when the bond was issued.
The date is known as the "maturity date," and may vary widely; for instance, some bonds mature ten years after issuance, while others mature thirty years after issuance. In many bonds, the investors also have the right to regular interest payments on their loan to the entity. Typically, the more certain the repayment of the bond, the lower the rate of return. A company's decision to issue bonds is often a major financial decision, since it places the company in debt. In some cases, government agencies are required to consult voters through a referendum election before issuing bonds.
A note payable (also known simply as a "note") is essentially a traditional loan. The term "note" comes from the typical use of a promissory note to immortalize the transaction. A note is characterized by having a specified principal amount and term of maturity. It has a particular interest rate as well, although that interest rate may be either fixed, or set to fluctuate based on the prime interest rate, depending on the legal terms of the loan agreement. Issuance of a note payable by a company may require approval by the company's board of directors.
Differences Between Bonds and Notes
For accounting purposes, bonds and notes payable receive similar treatment. Each is treated as a liability on the balance sheet, and usually, the interest to be paid is treated as a liability as well. Sometimes, the distinction between treatment of a debt as a note or a bond depends essentially on the length of the maturity date after issuance of the loan.
A bond is almost always treated as a security under federal securities laws. However, most notes aren't securities. Section 2(a)(1) of the Securities Act of 1933 creates a non-exclusive list of notes that don't qualify as securities, including notes secured by home mortgages, commercial paper notes, and various short-terms notes secured by certain business accounting assets. However, historically a note payable with a maturity date of more than 9 months will be legally presumed a security, until proven otherwise.
- AccountingTools.com: What Are Notes Payable?
- AccountingCoach.com: What Is the Difference between a Note Payable and a Bond Payable?
- SEC: Securities Act of 1933, Section 2
- Investopedia: Bond
- New Jersey School Board Association: Legally Speaking: How to Successfully Navigate Your Board Through the Referendum Process