A company raises its capital by means of an issue of shares. But the funds raised by the difficulty of shares are seldom capable meet their future financial needs of a corporation. Hence, most companies address raising long-term funds also through debentures which are issued either through the route of personal placement or by offering an equivalent to the general public. The finances raised through debentures also are referred to as long-term debt. It deals with the accounting treatment of issue and redemption of debentures and other related aspects.
The word ‘debenture’ has been derived from the Latin word ‘debere’ which suggests borrowing. its a written instrument acknowledging a debt under the common seal of the company. It contains a contract for repayment of principal after a specified period or at intervals or at the choice of the corporate and for payment of interest at a hard and fast rate payable usually either half-yearly or yearly on fixed dates. According to section 2(30) of the businesses Act, 2013 ‘Debenture’ includes Debenture Inventory, Bonds and the other securities of a corporation whether constituting a charge on the assets of the company or not.
Bond: Bond is additionally an instrument of acknowledgement of debt. Traditionally, the govt issued bonds, but lately, bonds also are being issued by semi-government and non-governmental organisations. The terms ‘debentures’ and ‘Bonds’ are now being used inter-changeably.
Ownership: A ‘share’ represents ownership of the corporate whereas a debenture is merely an acknowledgement of Debt. A share is a part of the owned capital whereas a debenture is a part of borrowed capital.
Return: The return on shares is understood as a dividend while the return on debentures is named interest. The rate of return on shares may vary from year to year depending upon the profits of the corporate but the speed of interest on debentures is prefixed. The payment of the dividend is an appropriation of profits, whereas the payment of interest may be a charge on profits and is to be paid albeit there’s no profit.
Repayment: The number of shares isn’t returned during the lifetime of the corporate, whereas, generally, the debentures are issued for a specified period and repayable on the expiry of that period. However, in the year 1998, the amendments (Section 77A and 77 B sub Section 2) in the Companies Act, permitted companies to buy back their shares especially when the market value of shares is less than its book value.
Voting Rights: Shareholders enjoy rights whereas debenture holders don’t normally enjoy any voting right. Security: Shares aren’t secured by any charge whereas the debentures are generally secured and carry a hard and fast or floating charge over the assets of the corporate.
Convertibility: The Shares cannot be converted into debentures whereas debentures can be converted into shares if the terms of an issue so provide, and in that case, these are known as convertible debentures.
A company may issue different kinds of debentures which can be classified as under follow:
1.The Point of view of Security:
(a) Secured Debentures: Secured debentures ask those debentures where a charge is made on the assets of the corporate for the aim of payment just in case of default. The charge may be fixed or floating. A fixed charge is made on a selected asset whereas a floating charge is on the overall assets of the corporate. The fixed cost is made against those assets which are held by a corporation to be used in operations not meant purchasable whereas floating charge involves all assets excluding those assigned to the secured creditors.
(b) Unsecured Debentures: Unsecured debentures don’t have a selected charge on the assets of the corporate. However, a floating charge could also be created on these debentures by default. Normally, these kinds of debentures are not issued.
2.The Point of view of Tenure:
(a) Redeemable Debentures: These are those which are payable on the expiry of the specific period either in a lump sum or in Instalments during the lifetime of the company. Debentures are often redeemed either at par or at a premium.
(b) Irredeemable Debentures: Irredeemable debentures also are referred to as Perpetual Debentures because the corporate doesn’t give any undertaking for the repayment of cash borrowed by issuing such debentures. These debentures are repayable on the winding-up of a corporation or on the expiry of an extended period.
3.The Point of view of Convertibility:
(a) Convertible Debentures: Debentures that are convertible into equity shares or in the other security either at the choice of the corporate or the debenture holders are called convertible debentures. Its are either fully convertible or partly convertible.
(b) Non-Convertible Debentures: The debentures which cannot be converted into shares or in any other securities are called non-convertible debentures. Most debentures issued by companies fall in this category.
4. Coupon Rate Point of view:
(a) Specific Coupon Rate Debentures: These debentures are issued with a specified rate of interest, which is called the coupon rate. The specified rate may either be fixed or floating. The floating interest rate is usually tagged with the bank rate.
(b) Zero-Coupon Rate Debentures: These debentures do not carry a specific rate of interest. In order to compensate the investors, such debentures are issued at a considerable discount and therefore the difference between the par value and the issue price is treated because of the amount of interest associated with the duration of the debentures.
5. The view Point of Registration:
(a) Registered Debentures: These are those debentures in respect of which all details including names, addresses and particulars of holding of the debenture holders are entered during a register kept by the corporate. Such debentures are often transferred only by executing a daily transfer deed.
(b) Bearer Debentures: Bearer debentures are the debentures that can be transferred by way of delivery and the company does not keep any record of the debenture holders Interest on debentures is paid to a person who produces the interest coupon attached to such debentures.
The procedure for the difficulty of debentures is that the same as that for the difficulty of shares. The intending investors apply for debentures on the idea of the prospectus issued by the corporate. The company may either ask for the entire amount to be paid on the application or by means of instalments on application, on the allotment and on various calls. Debentures are often issued at par, at a premium or at a reduction. They can even be issued for consideration aside from cash or as collateral security.
1. Issue of Debentures for Cash
Debentures are said to be issued at par when their issue price is adequate to the face value. The journal entries for such issue are as under:
(b) If the amount is received in two instalments:
(i) On receipt of application money
Bank A/c Dr.
To Debenture Application A/c
(ii) For adjustment of applications money on the allotment
Debenture Application A/c Dr.
To Debentures A/c
(iii) For allotment money due
Debenture Allotment A/c Dr.
To Debentures A/c
(iv) On receipt of allotment money
Bank A/c Dr.
To Debenture Allotment A/c
Note: Similar entries could also be made for the second call and final call. However, normally the whole amount is collected on the application or in two instalments, i.e., on application and allotment.
2. Issue of Debentures at a Discount
When a debenture is issued at a price below its par value, it’s said to be issued at a reduction. For example, the issue of Rs. 100 debentures at Rs. 95, Rs. 5 being the amount of discount. Discount on issue of debentures is a capital loss and is shown under the line item ‘Other Non-Current Assets’ or ‘Other Current Assets’ depending upon the time period in which it is to be written off. The discount on the issue of debentures can be written off either by debiting it to Statement of Profit and Loss or out of Securities Premium Reserve A/c, if any, during the lifetime of debentures.
Discount on issue of debentures to be written off within 12 months of the record date or the amount of operating cycle is shown under ‘Other Current Assets’ and the part which is to be written off after 12 months of the record is shown under ‘Other Non-Current Assets’. The Companies Act, 2013 doesn’t impose any restrictions upon the difficulty of debentures at a reduction.
3. Debentures issued at Premium
A debenture is claimed to be issued at a premium when the worth charged is quite its par value. For example, the difficulty of Rs 100 debentures for Rs 110, (Rs 10 is being the premium). The amount of premium is credited to the Securities Premium reserve fund and is shown on the liabilities side of the record under the top “Reserves and Surpluses”.
When the amount of debentures applied for is quite the amount of debentures offered to the general public, the difficulty is claimed to be oversubscribed. A company, however, cannot allot more debentures than it has invited for a subscription. The excess money received on oversubscription may, however, be retained for adjustment towards allotment and the respective calls to be made. But the cash received from applicants to whom no debentures are allotted is going to be refunded to them.
Sometimes a corporation purchase assets from vendors and rather than making payment in cash issues debentures for consideration thereof. Such issue of debentures is named debentures issued for consideration aside from cash. In that case, also, the debentures could also be issued at par, at a premium or at a reduction then entries made in such a situation are almost like those of the shares issued for consideration other than cash, which is as follows :
1. On purchase of assets
Sundry Assets A/c Dr.
2. On the issue of debentures
(a) At par
To Debentures A/c
(b) At a premium
To Debentures A/c
To Securities Premium Reserve A/c
© At a discount
Discount on Issue of Debenture A/c Dr.
To Debentures A/c
Collateral security could also be defined as a subsidiary or secondary or additional security besides the first security when a corporation obtains a loan or overdraft from a bank or any other Financial Institution. It may pledge or mortgage some assets as a secured loan against the said loan. But the lending institutions may enforce additional assets as collateral security in order that the quantity of loan is often realised fully with the assistance of collateral security in case the amount from the sale of principal security falls in need of the loan money. The corporate may issue its own debentures to the lenders in addition to other assets already pledged. Such a problem of debentures is understood as ‘Debentures issued as Collateral Security.
If the corporation fails to repay the loan alongside interest, the lender is liberal to receive his money from the sale of primary security and if the realisable value of the first security falls short to hide the whole amount, the lender has the proper to invoke the advantage of collateral security whereby debentures may either be presented for redemption or sold within the open market.
Debentures issued as collateral security can be dealt with within two ways in the books of the company:
No entry is formed within the books of accounts since no liability is made for such a problem. However, on the liability side of the record, below the item of loan, a note to the effect that it’s been secured by the difficulty of debentures as collateral security is appended. for instance, X Company has issued 9%, 10,000 debentures of Rs.100 each for a loan of Rs.10, 00,000 taken from a bank. This fact could even be shown within the record as under:
X Company Balance sheet as at_______________
Notes to Accounts
The issue of debentures as collateral security may be recorded by means of the journal entry as follows:
i. Issue of 10,000, 9% debentures of Rs. 100 each as collateral security for a bank loan of Rs. 10,00,000.
Debenture Suspense A/c Dr. 10,00,000
To 9% Debentures A/c 10,00,000
ii. For cancellation of 9% debentures as collateral security on repayment
of bank loan.
Debenture Suspense account will appear as a deduction from the debentures in notes to accounts of long-term borrowings. When the loan is repaid the above entry will be cancelled by a reverse entry :
9% Debentures A/c Dr. 10,00,000
To Debenture Suspense A/c 10,00,000
The balance sheet of X Co.___________ (Extract)
Notes to Accounts
When a corporation issues debentures, it’s under an obligation to pay interest thereon at a hard and fast percentage (half-yearly) periodically until debentures are repaid. This percentage is usually as part of the name of debentures like 8% debentures, 10% debentures, etc., and interest payable is calculated at the nominal value of debentures. Interest on debenture may be a charge against the profit of the corporate and must be paid whether the corporate has earned any profit or not. According to tax Act, 1961, a corporation must deduct tax at a prescribed rate from the interest payable on debentures if it exceeds the prescribed limit. It is called Tax Deducted at Source (TDS) and is to be deposited by tax authorities. Of course, the debenture holders can adjust this amount against the tax due from them.
1. Accounting Treatment
The following journal entries are recorded within the books of a corporation in reference to the interest on debentures:
1. When interest is due
Debenture Interest A/c Dr.
To Income Tax payable A/c
To Debentureholders A/c
(Being Amount of interest due on debenture and tax deducted at source )
2. For payment of interest to debenture holders A/c Dr.
To Bank A/c
(Being Amount of interest paid to debenture holders)
3. On transfer debenture Interest Account to a press release of Profit and Loss Statement of Profit and Loss Dr.
To Debenture Interest A/c
(Being Debenture interest transferred to profit and loss A/c)
4. On payment of tax deducted at source to the Government Income Tax Payable A/c Dr.
To Bank A/c
(Being Payment of tax deducted at source on interest on debentures)
The discount/loss on the issue of debentures may be a financial loss or a fictitious asset and, therefore, must be written-off during the lifetime of debentures. The amount of discount/loss on the issue of debentures should normally not be written-off within the year of the issue itself since the advantage of the debentures would accrue to the company till their redemption. The discount/loss on it is, therefore, treated as a capital loss. The discount may be charged to Securities Premium A/c or could also be written-off over 3 to five years through the statement of profit and loss as per guidelines issued by ICAI. In case, however, there are no capital profits or if the capital profits aren’t adequate, the quantity of such discount/loss are often written-off against the revenue profits per annum by passing the following journal entry.
Statement of Profit and Loss Dr.
To Discount/Loss on Issue of Debentures A/c
(Discount/loss on issue of debentures written-off)
There are two methods, which can be adopted to write off discount/loss on the issue of debentures against the revenue profits. These are as follows.
1. Fixed Instalment Method
When the debentures are redeemed at the end of a specified period, the total amount of discount should be written off in equal instalments of a fixed amount over that period. For example, if the debentures are to be redeemed after 10 years then out of the total amount of discount of Rs. 1,00,000, Rs. 10,000 will be written-off every year.
2. Fluctuating Instalment Method
When debentures are repaid by annual drawings or in instalments, the discount should be written-off within the ratio of debentures outstanding as at the top of every accounting year. the quantity of discount, under this method, goes on reducing year. the quantity of discount, under this method, goes on reducing once a year then this method also can be mentioned as Reducing Instalment Method.
For example, a company issues Rs. 15,00,000, 9% debentures at a discount of 10% redeemable by annual drawings of Rs. 3,00,000 at the end of each year. The amount of discount to be written-off will be calculated as under:
Year Amount utilised during the Year Ratio
First Year Rs. 15,00,000 5
Second Year Rs. 12,00,000 4
Third Year Rs. 9,00,000 3
Fourth Year Rs. 6,00,000 2
Fifth Year Rs. 3,00,000 1
Hence, the amount of discount to be written-off every year will be as under :
First Year Rs. 1,50,000 5/15 = Rs. 50,000
Second Year Rs. 1,50,000 4/15 = Rs. 40,000
Third Year Rs. 1,50,000 3/15 = Rs. 30,000
Fourth Year Rs. 1,50,000 2/15 = Rs. 20,000
Fifth Year Rs. 1,50,000 1/15 = Rs. 10,000
It refers to extinguishing or discharging the liability on account of debentures in accordance with the terms of the issue. In other words, the redemption of debentures means repayment of the quantity of debentures by the corporate. There are four ways by which the debentures are often redeemed. These are :
1. Payment in a lump sum
2. Payment in instalments
3. Purchase in the open market
4. By conversion into shares or new debentures
The company redeems the debentures by paying the amount in a lump sum to the debenture holders at the maturity thereof as per terms of issue.
2. Payment in instalments
Under this method, normally redemption of debentures is made in instalments on the specified date during the tenure of the debentures. The total amount of debenture liability is split by the amount of years. It is to notice that the particular debentures redeemable are identified by means of drawing the requisite number of lots out of the debentures outstanding for payment.
3. Purchase in the open market
When a corporation purchases its own debentures for the needs of cancellation, such an act of buying and cancelling the debentures constitutes redemption of debentures by purchase within the open market.
4. By conversion into shares or new debentures
It can redeem its debentures by converting them into shares or a replacement class of debentures. If debenture holders find that the offer is useful to them, they will exercise their right of converting their debentures into shares or a replacement class of debentures. These new shares or debentures are often issued at par, at a reduction, or at a premium. It should be noted that only the particular proceeds of debentures are to be taken under consideration for ascertaining the number of shares to be issued in lieu of the debentures to be converted. If debentures were originally issued at discount, the particular amount realized from them at the time of issue would be used because of the basis for computing the particular number of shares to be issued. It can be noted that this method is applicable only to convertible debentures.
The following factors should be taken into consideration by the company at the time of redemption of debentures :
I. Time of redemption of debentures
Generally, debentures are redeemed on the due date but a company may redeem its debentures before the maturity date if its articles provide for such.
II. Sources of Redemption of debentures
A company may source its redemption of debentures either out of capital or out of profits.
a) Out of Capital: Only those companies which are exempted from creating DRR may redeem debentures out of Capital.
b) Out of Profits: When any company planning to redeem its debentures purely out of profit, it should transfer 100 per cent of the face value of the redeemable debentures to DRR out of the surplus available for payment of dividend.
c) Out of Capital and Profits: In case, Company is planning to redeem its debentures by using both sources partially, it does not transfer 100 per cent of the face value of outstanding debentures of a particular class to DRR out of the surplus available for payment of dividend.
According to Rule 18(7) of COMPANIES (SHARE CAPITAL AND DEBENTURES) RULES, 2014, the company shall create a Debenture Redemption Reserve for the purpose of redemption of debentures, in accordance with the conditions are given below:
( a ) The Debenture Redemption Reserve shall be created out of the profits of the company available for payment of a dividend.
( b ) The company shall create Debenture Redemption Reserve (DRR) in accordance with the following conditions:
( i ) No DRR is required for debentures issued by All India Financial Institutions (AIFIs) regulated by the Reserve Bank of India and Banking Companies for both public as well as privately placed debentures.
( ii ) For NBFCs registered with the RBI and for Housing Finance Companies registered with the National Housing Bank, DRR is going to be 25% of the worth of outstanding debentures issued through the public issue as per present SEBI (Issue and Listing of Debt Securities) Regulations, 2008, and no DRR is required within the case of privately placed debentures.
( iii )For other companies including manufacturing and infrastructure companies, the adequacy of DRR will be 25% of the value of outstanding debentures issued through the public issue as per present SEBI (Issue and Listing of Debt Securities) Regulations,2008.
( iv ) 25% DRR is required within the case of privately placed debentures by listed companies. For unlisted companies issuing debentures on a private placement basis, the DRR will be 25% of the value of outstanding debentures.
( c ) Every company required to make Debenture Redemption Reserve shall on or before the 30th day of April in annually, invest or deposit, because the case could also be, a sum which shall not be but fifteen per cent, of the number of its debentures maturing during the year ending on the 31st day of March of subsequent year, in anybody or more of the subsequent methods, namely:-
i. Its deposits with any scheduled bank, free from any charge or lien;
ii. Its securities of the Central Government or of any State Government;
iii. Its securities mentioned in sub-clauses (a) to (d) and (ee) of section 20 of the Indian Trusts Act, 1882;
iv. The Bonds issued by the opposite company which is notified under subclause (f) of section 20 of the Indian Trusts Act, 1882;
v. the number invested or deposited as above shall not be used for any purpose aside from for redemption of debentures maturing during the year referred to above
( d) In the case of partly convertible debentures, Debenture Redemption Reserve shall be created in respect of the non-convertible portion of the debenture issue.
(e) The amount credited to the Debenture Redemption Reserve shall not be utilised by the corporate apart from the aim of redemption of debentures.
When, as per terms of the difficulty, the debentures are to be redeemed in instalments beginning from a specific year, the particular debentures to be redeemed are selected usually by draw of lots, and the redemption to be made either out of profits or out of capital. The entries will be:
2. If redeemed out of capital
(a) Debentures A/c Dr.
To Debenture holders
(b) Debentureholders Dr.
To Bank A/
When a corporation purchases its own debentures within the open marketplace for the aim of immediate cancellation, the acquisition and cancellation of such debentures are termed as redemption by purchase in the open market. The advantage of such an option is that a corporation can redeem the debentures at its convenience whenever it’s surplus funds. Secondly, the company can purchase them when they are available in the market at a discount. the debentures are purchased from the market at a discount and cancelled, the journal entries are as follows :
1. On purchase of own debentures for immediate cancellation
Debentures A/c Dr.
To Bank A/c
To Profit on Redemption of Debentures A/c
2. On transfer of Profit on Redemption
Profit on Redemption of Debenture A/c Dr.
To Capital Reserve
In case, the debentures are purchased from the market at a price that is above the par value of debenture, the surplus is going to be debited to loss on redemption of debentures. The journal entry, in that case, will be
1. Debentures A/c Dr.
Loss on Redemption of Debentures A/c Dr.
To Bank A/c
2. Statement of profit and loss Dr.
To Loss on Redemption of Debentures A/c
If debenture holders find that the offer is useful to them, they’re going to cash in on this offer & new shares or debentures may be issued at par, at a discount or at a premium. It may be noted that no Debenture Redemption Reserve is required in the case of convertible debentures because no funds are required for redemption.
Sufficient funds are required to redeem debentures at the top of a specified period. To meet this requirement, the company may decide to create a sinking fund and invest an adequate amount in marketable securities or bonds of other business entities. Normally, a corporation ensures that an equal amount is about aside per annum to rearrange the required funds at the time of redemption. This is called the fund method consistent with which the corporate makes necessary sets aside a part of divisible profit every year and invest the same outside the business in marketable securities.
An appropriate amount is calculated by pertaining to on fund Table depending upon the speed of return on investments and therefore the number of years that investments are made. The amount thus ascertained is transferred from profits per annum to Debenture Redemption Fund and its investment is termed as Debenture Redemption Fund Investment. These investments earn a certain amount of income (call it interest) which is reinvested together with the fixed appropriated amount for the purpose in subsequent years In the last year, the interest earned and therefore the appropriated fixed amount aren’t invested. The Debenture Redemption Fund Investments are encashed and therefore the amount so obtained is employed for the redemption of debentures. Profit and loss made on the encashment of Debenture Redemption Fund investments are also transferred to Debenture Redemption Fund Account.