Debt assumption is fairly easy to understand. It is when a third party takes upon itself another person or enterprise's debt. In essence, it involves three entities: the original debtor, a creditor and a new debtor. A simple example would be if a son (original debtor) owes $100 to the bank (creditor). The father (new debtor) signs a contract with the bank that he will pay them the $100, alleviating his son of the debt.
Two Actions Together
Debt assumption is really two actions taking place at once. The new debtor taking on the debt (first transaction) cancels the original debtor's contract while (second action) creating a new debt contract between the creditor and the assumer or new debtor.
Capital Transfer
In technical financial terms, the new person/entity taking on the other entity's debt is classified as "capital transfer." Typically, assets and their value are recorded by the creditor in the revaluation account.
Famous U.S. Debate on Debt Assumption
A very famous case of debt assumption in American history took place around 1790 and was caused by many members of Congress, led by Alexander Hamilton, which wanted the federal government to assume the debt of each state after the War of Independence.
Explanation of 1790 Debt Assumption Debate
This would mean, for example, that if Virginia was in debt to France for purchasing warships and ammunition for $10,000, New York was in debt to Spain for $5,000 for purchasing metal and so on, for each of the 13 states, then the new Congress of the United States would take upon itself the total $15,000 and leave each state debt-free.
Reasons for Hamilton's Debt Assumption
There was a general feeling in Congress that the Revolutionary War was the responsibility of the whole country and therefore it was logical that the federal government would take upon itself the debt. Also, the federal government did not want individual states to compete with the federal government for creditor's attention or for some states to become dependent upon other governments. Some states were heavily in debt and favored debt assumption, while other states had nearly paid their entire debt and were against it.
Commercial Uses
Debt assumption can take place not only among individuals and countries, but it is most commonly found in business entities where a company feels that taking on another company's debt in whole or in part, is in their best interest. An example would be if Coke found that an aluminum manufacturer was in deep debt and not able to produce the aluminum that Coke needed for its cans. Coke may take on some or all of the manufacture's debt to enable it to continue providing the resources Coke requires to run its business.
0 comments:
Post a Comment