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Accountancy: Class 12 (Part 2) — Chapter 2: Issue and Redemption of Debentures

1. Meaning and Features of Debentures

A company raises long-term capital through various instruments. When share capital is insufficient, it often raises long-term debt by issuing debentures. Debentures can be issued through private placement or offered to the general public.

Definition and Origin

The word "debenture" is derived from the Latin word debere, which means "to borrow". A debenture is a written instrument issued by a company acknowledging a debt under its common seal.

  • It contains a contract for the repayment of the principal amount after a specified period or at intervals.
  • It carries a fixed rate of interest payable half-yearly or yearly on specified dates.
  • According to Section 2(30) of the Companies Act, 2013, "debenture" includes debenture stock, bonds, or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

Distinction between Shares and Debentures

The fundamental differences between shares and debentures are summarized below:

Basis of Distinction Shares Debentures
Ownership Represents ownership of the company. Shareholders are owners. Represents an acknowledgment of debt. Debentureholders are creditors.
Return Dividend, which is an appropriation of profits (paid only when there is profit). Interest, which is a charge against profits (must be paid even if there is a loss).
Repayment Capital is generally not returned during the lifetime of the company. Repayable after a specified period as per the terms of issue.
Voting Rights Shareholders enjoy full voting rights. Debentureholders do not possess any voting rights.
Security Not secured by any charge on assets. Generally secured by a fixed or floating charge on the company's assets.
Convertibility Shares cannot be converted into debentures. Debentures can be converted into shares if terms of issue permit.
2. Types of Debentures

Debentures can be classified into various categories based on security, tenure, convertibility, coupon rate, and registration:

3. Accounting for Issue of Debentures

The accounting procedure for issuing debentures is highly similar to that of shares. Debentures can be issued at par, at a premium, or at a discount.

Issue of Debentures for Cash

Debentures are issued at par when the issue price equals the face value. Below are the standard journal entries when the amount is received in instalments:

Transaction Journal Entry Debit Credit
On receipt of application money Bank A/c
    To Debenture Application A/c		 Dr.
On allotment (transfer of application money) Debenture Application A/c
    To ...% Debentures A/c		 Dr.
On allotment money becoming due Debenture Allotment A/c
    To ...% Debentures A/c		 Dr.
On receipt of allotment money Bank A/c
    To Debenture Allotment A/c		 Dr.

Issue at a Discount and Premium
  • Issue at a Discount: When debentures are issued below nominal value. The discount is a capital loss and is debited to Discount on Issue of Debentures A/c.
  • Issue at a Premium: When debentures are issued above nominal value. The excess is credited to Securities Premium Reserve A/c.

Issue of Debentures for Consideration Other than Cash

When a company purchases assets or a business from vendors, it may issue debentures instead of paying cash. The number of debentures to be issued is calculated as:

$$\text{Number of Debentures} = \frac{\text{Purchase Consideration}}{\text{Issue Price of a Debenture}}$$

If the purchase consideration exceeds the net assets acquired, the difference is debited to Goodwill A/c. If the net assets acquired exceed the purchase consideration, the difference is credited to Capital Reserve A/c.

Issue of Debentures as Collateral Security

Collateral security refers to secondary or additional security provided to a lender in addition to the primary security. There are two methods of accounting treatment:

  1. First Method (No Entry): No journal entry is passed for the issue of debentures. A disclosure note is appended under the loan item in the Balance Sheet.
  2. Second Method (With Entry): A journal entry is passed debiting Debenture Suspense A/c and crediting Debentures A/c. In the Balance Sheet, the Debenture Suspense balance is deducted from the total debentures.
4. Terms of Issue and Redemption

The terms of issue dictate the conditions under which debentures will be redeemed at maturity. There are six common scenarios:

  1. Issued at par and redeemable at par
  2. Issued at a discount and redeemable at par
  3. Issued at a premium and redeemable at par
  4. Issued at par and redeemable at a premium
  5. Issued at a discount and redeemable at a premium
  6. Issued at a premium and redeemable at a premium

When debentures are redeemable at a premium, the premium on redemption is a liability. The loss is recognized at the time of issue by debiting Loss on Issue of Debentures A/c and crediting Premium on Redemption of Debentures A/c.

5. Interest on Debentures

Interest on debentures is calculated on the nominal (face) value of the debentures and is paid periodically. It is a charge against profits.

Accounting Treatment and TDS

Under the Income Tax Act, companies must deduct tax at source (TDS) from the interest payable to debentureholders and deposit it with the government.

Step Journal Entry Debit Credit
1. When interest becomes due Debenture Interest A/c
    To Debentureholders A/c
    To Income Tax Payable (TDS) A/c		 Dr.
2. On payment of interest Debentureholders A/c
    To Bank A/c		 Dr.
3. On payment of TDS to Government Income Tax Payable A/c
    To Bank A/c		 Dr.
4. Transfer of interest to P&L Statement of Profit and Loss
    To Debenture Interest A/c		 Dr.
6. Redemption of Debentures

Redemption of debentures refers to the discharge of liability by repaying the principal amount to the debentureholders.

Methods of Redemption
  • Payment in Lump Sum: The entire amount is paid to debentureholders at maturity.
  • Payment in Instalments (Draw of Lots): Debentures are redeemed in parts annually or at specified intervals.
  • Purchase in Open Market: The company buys its own debentures from the open market for immediate cancellation, often when they trade at a discount.
  • Conversion: Debentures are redeemed by converting them into equity shares or new debentures.

Legal Provisions: DRR and DRI

To protect the interests of debentureholders, the law mandates specific reserves and investments:

  • Debenture Redemption Reserve (DRR): Created out of profits available for dividend. Certain classes of companies (like unlisted companies) must maintain a DRR equal to 10% of the value of outstanding debentures.
  • Debenture Redemption Investment (DRI): Companies required to create DRR must invest or deposit a sum equal to at least 15% of the nominal value of debentures maturing during the year ending on March 31st of the next year. This investment must be made on or before April 30th of the current year.