01 · Explore
Meaning and Characteristics of Debentures
A company requires significant capital for long-term needs, which it often raises by borrowing from the public through debentures.
The term 'debenture' originates from the Latin word 'debere', meaning to borrow. It is a written instrument issued by a company under its common seal as an acknowledgement of debt. It contains a contract for the repayment of the principal amount after a specified period and the payment of interest at a fixed rate on specific dates.
According to Section 2(30) of the Companies Act, 2013, a debenture includes debenture stock, bonds, and any other securities of a company, whether they constitute a charge on the company's assets or not. While traditionally the government issued bonds, today semi-government and non-governmental organisations also issue them, and the terms 'debenture' and 'bond' are often used interchangeably.
Debentures represent borrowed capital, not owned capital. Unlike shareholders, debentureholders are creditors of the company and do not possess voting rights. The interest paid to them is a 'charge against profit', meaning it must be paid even if the company makes no profit.
| Basis | Shares | Debentures |
|---|---|---|
| Ownership | Represents ownership (Owned Capital). | Represents debt (Borrowed Capital). |
| Return | Dividend (Appropriation of profit). | Interest (Charge against profit). |
| Repayment | Normally, the amount of shares is not returned during the life of the company. | Repayable after a specified period. |
| Voting Rights | Shareholders enjoy voting rights. | Debentureholders have no voting rights. |
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Why is interest on debentures considered a 'charge against profit'?
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02 · Explore
Classification of Debentures
Debentures can be classified based on security, tenure, convertibility, coupon rate, and registration.
From the point of view of security, debentures are either Secured (Mortgage) or Unsecured (Naked). Secured debentures create a charge on the company's assets, which can be 'fixed' (on specific assets like land) or 'floating' (on general assets). Unsecured debentures do not have such specific protection.
Based on tenure, Redeemable debentures are those payable after a specific period, while Irredeemable (Perpetual) debentures are repayable only upon the winding up of the company. In terms of convertibility, Convertible debentures can be changed into equity shares at a later date, whereas Non-convertible debentures cannot.
Coupon rate classification includes Specific Rate debentures, which have a fixed or floating interest rate, and Zero Coupon Rate debentures, which carry no specific interest but are issued at a heavy discount. Finally, Registered debentures require the holder's details in the company's records, while Bearer debentures are transferable by simple delivery.
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What is the difference between a fixed charge and a floating charge?
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How do Zero Coupon Rate debentures compensate investors?
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03 · Explore
Issue of Debentures for Cash at Par
When debentures are issued at a price equal to their face value, they are said to be issued at par.
The accounting procedure for issuing debentures is similar to that of shares. A company issues a prospectus, and investors apply for the debentures. The company may collect the money in a single lump sum or through instalments (Application, Allotment, and Calls).
If the amount is received in instalments, the first entry records the receipt of application money in the Bank Account. This is then transferred to the Debentures Account upon allotment. Subsequent instalments like Allotment and Calls are first 'due' (recorded as a receivable) and then 'received' in the bank.
Instalment Issue at Par
Application: 10,000 * 40 = 4,00,000; Allotment: 10,000 * 60 = 6,00,000
A company issues 10,000 debentures of 100 each. 40 is due on application and 60 on allotment. Total received is 10,00,000.
- 1
Bank A/c Dr. to Debenture Application A/c (Receipt of application money)
- 2
Debenture Application A/c Dr. to Debentures A/c (Application money transferred to debentures account on allotment)
- 3
Debenture Allotment A/c Dr. to Debentures A/c (Allotment money due)
- 4
Bank A/c Dr. to Debenture Allotment A/c (Receipt of allotment money)
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If a company receives application for 5,000 debentures of 100 each and asks for the full amount at once, what is the entry?
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04 · Explore
Issue of Debentures at Discount or Premium
Debentures can be issued at a price lower than face value (Discount) or higher than face value (Premium).
When issued at a discount, the 'Discount on Issue of Debentures' is a capital loss. It must be written off in the year of issue, preferably using the Securities Premium Reserve or the Statement of Profit and Loss. There are no legal restrictions on the maximum discount allowed for debentures.
When issued at a premium, the excess amount is credited to the 'Securities Premium Reserve' account. This account is shown under 'Reserves and Surplus' on the liabilities side of the Balance Sheet. The premium is usually recorded at the time of allotment.
| Scenario | Account Debited | Account Credited |
|---|---|---|
| Issue at Discount | Discount on Issue of Debentures A/c | Debentures A/c (with full face value) |
| Issue at Premium | Debenture Allotment A/c (with amount due including premium) | Debentures A/c (with nominal value) and Securities Premium Reserve A/c (with premium) |
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Where is the 'Securities Premium Reserve' shown in the Balance Sheet?
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05 · Explore
Issue for Consideration Other Than Cash
Companies may issue debentures to vendors as payment for assets or businesses purchased.
When a company buys assets, it debits the Sundry Assets account and credits the Vendor's account. To settle the payment, it issues debentures. If issued at par, the Vendor is debited and Debentures are credited. If issued at a premium or discount, the number of debentures must be calculated carefully.
The formula to find the number of debentures to be issued is: Purchase Consideration divided by the Issue Price per debenture. If a whole business is taken over, the difference between the net assets (Assets - Liabilities) and the purchase consideration is treated as Goodwill (if consideration is higher) or Capital Reserve (if consideration is lower).
Calculating Number of Debentures
Number = 1,98,000 / 110 = 1,800 debentures
Machinery purchased for 1,98,000. Debentures of 100 each issued at 10% premium (Issue price = 110). 1,800 debentures are issued.
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What happens if the value of debentures issued is less than the net assets taken over in a business purchase?
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06 · Explore
Debentures as Collateral Security
Debentures issued as collateral security act as a secondary or subsidiary security for a loan.
When a company takes a loan from a bank, it may provide primary security (like land). If the lender requires additional security, the company may issue its own debentures to the lender. These debentures do not carry interest as long as the loan is serviced regularly; interest is paid only on the bank loan.
There are two accounting methods. In the first method, no journal entry is passed for the issue; a note is simply added to the Balance Sheet under the loan item. In the second method, a journal entry is passed: debiting 'Debenture Suspense A/c' and crediting 'Debentures A/c'. In the Balance Sheet, the Debenture Suspense is deducted from the Debentures in the Notes to Accounts.
Accounting for Collateral Security (Method 2)
- 1
Loan Receipt
Bank A/c Dr. to Bank Loan A/c (Recording the actual liability).
- 2
Collateral Issue
Debenture Suspense A/c Dr. to Debentures A/c (Recording the secondary security).
- 3
Loan Repayment
Bank Loan A/c Dr. to Bank A/c (Settling the primary debt).
- 4
Cancellation
Debentures A/c Dr. to Debenture Suspense A/c (Reversing the collateral entry).
This sequence shows how collateral debentures are recorded and subsequently cancelled upon loan repayment.
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Question
Does the company pay interest on debentures issued as collateral security?
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07 · Explore
Terms of Issue and Redemption
The accounting for the issue of debentures is often influenced by the terms under which they will be redeemed.
Redemption means the repayment of the debenture amount. Debentures can be issued at par, premium, or discount, and redeemed at either par or premium. If debentures are redeemable at a premium, this future liability is recognized at the time of issue as a loss.
The 'Premium on Redemption of Debentures' is a liability and is shown under 'Long-term Borrowings'. The corresponding debit is made to 'Loss on Issue of Debentures A/c'. This account covers both the discount allowed at issue and the premium to be paid at redemption.
| Case | Debit Account | Credit Account |
|---|---|---|
| Issued at Par, Redeemable at Premium | Loss on Issue of Debentures | Premium on Redemption of Debentures |
| Issued at Discount, Redeemable at Premium | Loss on Issue (Discount + Premium) | Premium on Redemption of Debentures |
| Issued at Premium, Redeemable at Premium | Loss on Issue (Redemption Premium) | Premium on Redemption of Debentures |
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Why is 'Loss on Issue of Debentures' debited when debentures are redeemable at a premium?
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08 · Explore
Interest on Debentures and TDS
Interest is a periodic payment made to debentureholders, usually calculated on the nominal value.
Interest is typically paid half-yearly. As per the Income Tax Act, 1961, companies must deduct tax at source (TDS) if the interest exceeds a certain limit. This deducted amount is a liability for the company until deposited with the government.
The accounting involves four steps: making the interest due (including TDS), paying the debentureholders, depositing the TDS with the government, and finally transferring the total interest expense to the Statement of Profit and Loss at the end of the year.
Interest Calculation with TDS
Gross Interest: 2,00,000 * 10% * 6/12 = 10,000; TDS: 10,000 * 10% = 1,000; Net Payable: 9,000
On 2,00,000 worth of 10% debentures, half-yearly interest is 10,000. With 10% TDS, 1,000 goes to the government and 9,000 to the holder.
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Is interest on debentures paid on the issue price or the face value?
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09 · Explore
Methods of Redemption
Redemption is the process of extinguishing the debenture liability through various repayment methods.
There are four primary methods: 1. Lump sum payment at maturity. 2. Payment in instalments (Draw of Lots). 3. Purchase in the open market for immediate cancellation. 4. Conversion into new shares or debentures.
Companies (except certain exempted categories like All India Financial Institutions and Banking Companies) must follow statutory requirements for redemption. This includes creating a Debenture Redemption Reserve (DRR) and making a Debenture Redemption Investment (DRI).
For 'other unlisted companies', the adequacy of Debenture Redemption Reserve shall be ten percent of the value of the outstanding debentures. Furthermore, companies are required to invest or deposit a sum not less than 15% of the amount of debentures maturing during the year in specified securities on or before April 30th.
The Redemption Process (Lump Sum)
- 1
Investment (DRI)
Invest 15% of maturing value in specified securities by April 30.
- 2
Reserve (DRR)
Transfer required percentage of profits to DRR account.
- 3
Realisation
Encash the DRI just before the redemption date.
- 4
Payment
Transfer amount to Debentureholders and pay via Bank.
- 5
Closing DRR
Transfer the balance in DRR to General Reserve after redemption.
This flow outlines the statutory and accounting steps required to redeem debentures in a lump sum.
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What is the 'Draw of Lots' method?
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10 · Explore
Redemption by Purchase in Open Market and Conversion
Companies can also redeem debentures by buying them back from the stock market or converting them into equity.
Purchase in Open Market: A company may buy its own debentures when they are trading at a discount. If purchased for immediate cancellation, the difference between the face value and the purchase price is 'Profit on Redemption', which is transferred to the Capital Reserve.
Conversion: Debentureholders may be given the option to convert their debt into equity shares. The number of shares issued is based on the 'actual proceeds' of the debentures. If they were originally issued at a discount, the amount actually realized is used for the calculation.
When debentures are purchased at a price higher than the nominal value, the excess is treated as a 'Loss on Redemption' and is debited to the Statement of Profit and Loss.
Profit on Open Market Purchase
Face Value: 20,000; Purchase Price: 20,000 * 0.92 = 18,400; Profit: 1,600
A company buys back its 20,000 debentures at 92 each. The difference of 1,600 is the Profit on Redemption, which is transferred to the Capital Reserve.
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Where is the profit on cancellation of own debentures transferred?
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Can a company issue new shares at a premium during conversion?
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