Company Accounts: Issue of Debentures
Meaning of Debentures and Share vs Debenture
Besides shares, a company can raise long-term funds by borrowing — and a common instrument of borrowing is the debenture. A debenture is a written acknowledgement of a debt by the company, usually carrying a fixed rate of interest and a promise to repay (redeem) the principal on a stated date. A debenture-holder is a creditor of the company, not an owner.
The contrast with a share is a favourite exam question:
| Basis | Share | Debenture |
|---|---|---|
| Status of holder | Owner (member) | Creditor (lender) |
| Return | Dividend (variable, only if profit) | Interest (fixed, paid even in a loss) |
| Voting rights | Yes (equity) | No |
| Repayment | Generally not (except on winding up/buy-back) | Redeemed on a fixed date |
| Security | Unsecured | Usually secured by a charge on assets |
Debentures are of several types: by security (secured/mortgage vs unsecured/naked); by convertibility (convertible into shares vs non-convertible); by permanence (redeemable vs irredeemable); and by records (registered vs bearer). Because debenture interest is a charge against profit (an expense), it is paid whether or not the company earns a profit — a key difference from a dividend, which is an appropriation of profit. This makes debentures cheaper but riskier (fixed commitment) than equity.
A lender.
- A debenture is a debt, so the holder is a creditor (lender), not an owner.
Dividend vs interest.
- Shares get a variable dividend (only if profit); debentures get fixed interest (paid even in a loss).
A charge.
- It is an expense (charge against profit), paid regardless of profit.
Key Points
- Debenture = acknowledgement of a debt, fixed interest, redeemed on a date; holder is a creditor.
- Share vs debenture: owner/dividend/voting/usually unsecured vs creditor/interest/no vote/usually secured.
- Debenture interest is a charge against profit (paid even in a loss); a dividend is an appropriation.
Issue of Debentures at Par, Premium and Discount
Like shares, debentures can be issued at par, at a premium or (unlike shares) at a discount. The money is usually collected in instalments, but the entries are commonly shown assuming the full amount on application for simplicity.
- At par: Bank A/c Dr / To Debentures A/c (face value).
- At premium: Bank A/c Dr / To Debentures A/c (face value) and To Securities Premium Reserve A/c (the premium).
- At discount: Bank A/c Dr (net) and Discount on Issue of Debentures A/c Dr (the discount) / To Debentures A/c (face value).
For example, a Rs 100 debenture issued at Rs 95 (discount Rs 5): Bank 95 + Discount 5 / To Debentures 100. The Discount on Issue of Debentures is a capital loss, shown on the assets side / written off over the life of the debentures against the Securities Premium Reserve or the Statement of Profit and Loss.
The twist with debentures is the terms of redemption, which create extra possibilities at issue. A debenture may be issued at par or premium or discount AND redeemable at par or premium. When debentures are redeemable at a premium, the company knows at issue that it will have to pay extra on redemption, so it provides for it now: it debits a Loss on Issue of Debentures A/c with the redemption premium and credits a Premium on Redemption of Debentures A/c (a liability). This conservative recognition of a known future loss reflects the prudence concept. The various combinations (e.g. issued at discount, redeemable at premium) are a classic numerical, but each is just an application of these basic entries.
Face value in.
- Bank A/c Dr 100; To Debentures A/c 100.
Discount on issue.
- Discount on Issue of Debentures A/c Dr 4 (a capital loss).
- Bank 96 + Discount 4 / To Debentures 100.
Securities Premium.
- To Securities Premium Reserve A/c.
Key Points
- At par: Bank Dr / To Debentures. At premium: + To Securities Premium Reserve. At discount: + Discount on Issue Dr.
- Debentures (unlike shares) may be issued at a discount; the discount is a capital loss written off over their life.
- Redeemable at a premium: provide now — Loss on Issue Dr, Premium on Redemption (a liability) Cr (prudence).
Issue for Consideration and Terms of Redemption
Debentures need not be issued only for cash. Two special cases are common.
1. Issue for consideration other than cash. When a company buys an asset (or a whole business) and pays by issuing debentures instead of cash, the steps are: record the purchase (debit the assets, credit the vendor), then settle the vendor by issuing debentures (Vendor A/c Dr / To Debentures A/c, with any premium/discount). If the purchase consideration exceeds the net assets acquired, the excess is goodwill; if it is less, the difference is a capital reserve.
2. Issue as collateral security. Debentures may be issued to a bank as a secondary (collateral) security for a loan — they become payable only if the company defaults. Two treatments: either pass no entry (just a note below the loan in the balance sheet), or pass an entry debiting Debenture Suspense A/c and crediting Debentures A/c.
Terms of redemption. Combining issue and redemption terms gives the well-known cases. The amount the company will ultimately repay depends on whether debentures are redeemable at par or at a premium. When redeemable at a premium, the extra is recognised at issue via the Loss on Issue of Debentures and Premium on Redemption accounts (as seen earlier). For example, debentures of Rs 1,00,000 issued at a discount of 5% but redeemable at a premium of 10% create a total capital loss of Rs 5,000 (discount) + Rs 10,000 (redemption premium) = Rs 15,000, debited at issue. Debenture interest, meanwhile, is paid periodically (net of TDS where applicable) and charged to the Statement of Profit and Loss as finance cost. With issue, consideration, collateral and redemption terms understood, the accounting for a company's borrowed capital is complete — ready to appear in the financial statements studied next.
Net assets > consideration.
- Net assets 4,40,000 − consideration 4,00,000 = 40,000.
- Consideration is less than assets → Capital Reserve Rs 40,000.
Secondary security.
- Debentures given to a lender as additional security, payable only on default.
Redemption premium.
- 10% of 1,00,000 = 10,000 (Loss on Issue / Premium on Redemption).
Key Points
- Issue for consideration other than cash: settle the vendor by issuing debentures; excess of consideration over net assets = goodwill, shortfall = capital reserve.
- Collateral security: either no entry (note in balance sheet) or Debenture Suspense A/c Dr / To Debentures A/c.
- Redeemable at a premium: provide the premium at issue (Loss on Issue / Premium on Redemption); interest is a finance cost in the Statement of P&L.