A debenture is an instrument of acknowledgement of debt under the common seal of a company. It contains contract for the repayment of the principal sum at a specified date and for the payment of interest at a fixed rate per cent until the principal sum is repaid. Repayment of interest is usually half-yearly.
The Comapnies Act defines debentures as—‘Debenture includes debentrue stock, bonds or any other securities of a company whether consisting a charge on the assets of the company or not.’
Types of debentures
Simple Debentures : Simple debentures do not carry any security in respect of its re-payment. The company promises to pay interest due and repays principal in the event of company’s winding up. They come in the same category as any other insecured creditors with regard to their claim.
Secured or Mortgaged Debentures: These debentures are secured by a charge on some assets or property of the company. The debenture holders have a right to recover principal amount of assets mortgaged by the company.
Bearer Debentures : The ownership of these debentures is transferred simply by physical transfer of the debentures. Therefore, interest and principal is paid to bearers of debentures.
Registered Debentures : Name, address and particulars of the bearer of this type of debentures are entered in a register kept by the company. Transfer of debentures requires the execution of regular transfer deed.
Redeemable Debentures : These debentures are paid back either after the expiry of a certain period or after giving due notice.
Irredeemable Debentures : The company is not bound to repay such debentures. They are paid back at the time of winding up of the company or when interest due is not paid.
There are other types of debentures also, such as 1. Convertible debentures, 2. Non-Convertible debentures, 3. First Debentures, and 4. Second Debentures.
Distinction between share and debentures
Position in Enterprise : A share- holder is a part-owner of the company, whereas a debenture-holder is a creditor of the company.
Voting Right : A shareholder has a voting right in the general body meeting of the company, whereas a debenture holder has no such right.
Order of Repayment : In the case of winding up of a company the amount due on debentures must be repaid in full before any repayment in made to the share holders.
Income : The debentures-holders receive interest at the stated rate irrespective of size of profits, whereas a shareholder is paid dividend at a rate predetermined by the board of directors and that too when there is profit.
Restrictions : There are legal restrictions on the issue of share at a discount but the debentures can be issused at discount without any restriction.
Condition of Refund : The amount of debentures must be refunded as promised. In the case of shares, the amount is not payable during the life-time of the company except in the case of redeemable preference shares.
Issue of debentures
The procedure for issuing debentures is very much similar to that of an issue of shares. In this connection, a prospectus is prepared and is issued to invite applications on a prescribed form. On receipt of applications, letters of allotment or regret, as the case may be, are issued. The company may ask for the payment of the whole amount alongwith the application or in instalments. The application forms are deposited with the company’s bankers along with the application money.
Debentures may be issued in the following ways :
(i) For Cash
(ii) For consideration other than Cash
(iii) As collateral security.
On Receiving Application Money:
Bank A/c Dr
To Debenture Application A/c
(For the amount received on application)
On Transferring the Application Money to Debenture Account:
Debenture Application A/c Dr
To Debenture A/c
(For the application money transferred to the Debenture account)
On Refunding the amount of Rejected Applications :
Debenture Application A/c
To Bank A/c
(For the applicatin money refunded to those applicants to whom debentures have not been issued)
On Transferring the Amount of Applicants to whom Debntures Issued Partially
Debenture Application A/c Dr
To Debenture Allotment A/c
(For the surplus amount on partly accepted applications transferred to debenture allotemnt account)
On Allotment of Debentures :
(a) At Par
Debenture Allotment A/c Dr
To Debenture A/c
(For the amount due on the allotment of debentures at par)
(b) At Premium
Debenture Allotment A/c Dr
To Debenture A/c
To Premium on Issue of
Debenture A/c
(For the amount due on the allotment of debentures at premium)
(c) At Discount
Debenture Allotment A/c Dr
Discount on Issue of
Debenture A/c Dr
To Debenture A/c
(For the amount due on the allotment of debentures at discount)
On Receipt of Allotment Money :
Bank A/c Dr
To Debenture A/c
(For allotment money on debentures received)
When the First & Final Call Becomes Due :
Debenture First and
Final Call A/c Dr.
To Debentrue A/c
(For the amount due on 1st & final call)
On Receipt of First and Final Call Money:
Bank A/c Dr
To Debenture First & Final Call
A/c
(For debenture 1st and final call money received)
On Receipt of Total Amount of Debentures Along with Application:
(a) At Par
Bank A/c Dr
To Debenture A/c
(For the full and final amount received on the allotment of debentures at par)
(b) At Premium
Bank A/c Dr
To Debenture A/c
To Premium on Issue of
Debenture A/c
(For the full amount received on the issue of debentures at premium)
(c) At Discount
Bank A/c Dr
Discount on Issue of
Debentrue A/c Dr
To Debenture A/c
(For the full amount received on the issue of debentures at discount)
Issue of debentures for consideration other than cash
When a company issues debentures to purchase an asset, it is known as issue of debentures for consideration other than cash. Following journal entries are made in this respect:
On Purchase of Assets :
Assets A/c Dr
To Vendor
(For assets purchased)
On Issue of Debentures Against Assets :
Vendor Dr.
To Debenture A/c
(For debentures issued to vendor to purchase assets from him)
Note : Debentures can be issued at par, premium and discount for consideration other than cash to purchase assets.
Place of debentures in the balance sheet
(i) Debentures are shown on the liabilities side of balance sheet under the head ‘Secured Loans’, or ‘Unsecured Loans.’
(ii) Discount on issue of debentures is shown on the assets side of balance sheet under the head ‘Miscellaneous Expenditures’. This amount is divided into some years and written off every year.
(iii) Premium on debentures is shown on the liabilities side of balance sheet under the head ‘Reserves and Surplus’.
issue of debentures as collateral security
Issue of debenture as collateral security means issue of debentures as a subsidiary or secondary security. Collateral security is to be realised only when the principal security fails to pay the amount of loan. Sometimes, when a company takes loan, it may have to issue debentures for the same amount or even for a higher amount. These debentures will not carry any right as long as the terms of the loan are not contravened. But if there is any breach, the creditor may claim all the rights of a debenture holder. Debentures issued as collateral security can be dealt within two ways :
First Method : No entry is made in the books. However, the fact of the issue is to be disclosed in the balance sheet. This is done by mentioning the fact alogwith the loan, shown as follows :
Balance Sheet
(Relevant Portion Only)
Liabilities Amount
Secured Loans:
Bank Loan (Secured by the
issue of 6% debentures as
collateral security)
Second Method : Sometimes issue of debentures as collateral security is recorded by making a journal entry as follows :
Debenture Suspense A/c Dr
To Debenture A/c
(For Debenture issued as collateral security debited to suspense account)
When the loan is paid, the above entry is cancelled by means of a reverse entry given below :
Debenture A/c Dr
To Debenture Suspense A/c
(For entry made on payment of loan to the bank)
Issue of Debentures with conditions of Redemption
Sometimes, a company issues debentures with specific terms and conditions at which redemption will be made. Some of these conditions are in the interest of the company and the others are useful to the debenture holders. In this way, debentures are issued with the following terms and conditions :
When Debentures are Issued at Par and Redeemed at Par :
Bank A/c Dr
To Debenture A/c
(For debenture issued at par and repayable at par)
When Debenture are Issued at Discount and Redeemed at par :
Bank A/c Dr
Discount an Issue of Debenture A/c
To Debenture A/c
(For debentures issued at discount to be redeemed at par)
When Debentures are Issued at Premium & Repayable at par :
Bank A/c Dr
To Debanture A/c
To Premium on Issue of
Debentures A/c
(For debentures issed at premium & redeemable at par)
When Debentures are Issued at Par and Redemable at Premium :
Bank A/c Dr
Loss on Issue & Debenture A/c Dr
To Debenture A/c
To Premium on Redemption to
Debentures A/c
(For debentures issued at par & redeemable at premium)
When debentures are Issued at Discount and Redeemable at Premium :
Bank A/c Dr
Loss on Issue of Debentures A/c Dr
To Debenture A/c
To Premium on Redemption of Debentures A/c
(For debentures issued at discount & repayable at premium)
writing off loss and discount on issue of debentures account
Discount or loss on issue of debentures is a fictitious asset. It is shown in the balance sheet untill it is witten off. There is no time limit to write off the amount of discount or loss in the books of accounts. But it is considered proper that the amount of such a fictitious asset is debited to Profit & Loss Account and written off. For this purpose, following journal entry will be made :
Profit & Loss A/c Dr
To Dicount (Loss) on Issue of Debentures written off
This amount of discount or loss is written off by the following two methods :
First Method : When the amount of all the debentures is paid after a fixed period.
In case of all the debentures to be redeemed within a fixed period, amount of discount is debited every year equally to Profit & Loss Account and thus written off. For example, a Company issued debentures worth Rs. 50,000 for 5 years at a discount of Rs. 500. In this case Rs. = Rs. 100 will be debited to Profit & Loss Account every year.
Second Method : When a part of debentures is redeemed or payment is made in intallments every year.
In case debentures are redeemed by regular annual installments, the first method does not hold good. The reason is clear that the weight of discount is not divided proportionately. Therefore, another method of writing off the amount of discount is adopted. According to this method, the total discount is written off during the life time of debentures in proportion to the debentures outstanding at the beginning of each year.
For example, a company issued debentures worth Rs. 50,000 and the company redeems debentures amounting to Rs. 10,000 every year. The whole amount of loan will be repaid in five years. In this condition, if there is any amount of discount, it will be written off from the books of account of the company in five years. The amount of discount written off every year will be in proportion to the amount used by the company during these years. Usage of loan by the comapny during these years will be as follows:
Year Rs.
First year 50,000
Second year 40,000
Third year 30,000
Fourth year 20,000
Fifth year 10,000
The ratios of amounts used during these five years will be 5:4:3:2:1. The amount of discount will be written all from the books of accounts in this proportion. If the total of discount is
Rs. 6000, the amount to be written off at the end of 1st year will be Rs. 2000 or.
In this way, the amount to be written off every year can be calculated.
Interest on Debentures
Interest is paid on debentures every year. According to Income Tax Act, a company should make payment of interest on loan after deducting income tax from it and deposit income tax fund every year. The following journal entries are made in this connection :
When Interest is Due on Debentures:
Interest on Debentures A/c Dr
To Debentures Holder’s A/c
To Income Tax Payable A/c
(For interest on debentures became due to debentures holder after deducting income tax.)
On Payment of Interest on Debentures :
Debentures Holder’s A/c Dr
To Bank/Cash A/c
(For interest paid in Cash)
On Payment of Income Tax
Income Tax Payble A/c Dr
To Bank A/c
(For income tax being deducted and paid at source)
At the end of the year, interest on debentures is transferred to Profit & Loss Account.
An example of it follows :
Profit & Loss A/c Dr
To Interest on Debentures A/c
(For interest on debentures transferred to profit and loss account).
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