Asok Nadhani-Accountancy-Company Accounts - Debentures

Debenture

By Asok Nadhani

28.1 Debenture

i.      A debenture is a document issued by the company as evidence of its debt. It is an acknowledgement of the company’s indebtness to its holders. 

ii.     The term Debenture includes debenture stock, bonds and any other security of a company, whether constituting a charge on the assets of the company or not. [Sec. 2 912)]

iii.    Debenture is the most common form of loan capital on a long term basis. To arrange huge amounts of long term loan capital (bearing a fixed rate of interest) a company issues debentures to the investing public splitting the amounts into many units.

iv.    As per the Section 2(12) of the Companies Act, Debenture includes debenture stock bonds and any other securities of a company whether constituting a charge on the company’s asset or not.

28.1.1 Difference between and Shares and Debentures

Basis of Difference	Shares	Debentures
1. Status	Shareholders are owners of the company.	Debenture holders are creditors of the company.
2. Voting right in G.M.	Share holders have voting rights in the General meeting of company.	Debenture holders have no voting rights in the General meeting of company.
3. Balance Sheet	The value of shares is shown under “Share Capital” in the Balance Sheet.	Debentures are shown under “Secured Loans” in the Balance Sheet.
4. Return on Investment	Dividends can be paid to share holders out of profit of the company only.	Debenture holders get a fixed rate of interest whether there is profit or not.
5.Convertibility	Shares can not be converted into debentures.	Debentures can be converted into shares as per the terms of the company.
6. Charge against profit	Dividends on shares are appropriation of profit, and not deducted to determine taxable income.	Interests on debentures are charged against profit and are deducted as an expense to determine taxable income.
7. Priority of Repayment	At the time of liquidation, shareholders are paid at last, after paying debenture holders and creditors.	At the time of liquidation, debenture holders must be paid off before payment of shareholders.

28.2 Types of Debenture

a.     Classification as per transferability

i.      Registered debentures: These debentures are payable to the registered holders hose name appears in the Register of debenture. These are not easily transferable.

ii.    Bearer (or Unregistered) debentures: These are negotiable instrument and easily transferable. It bears no stamp duty and no record is kept in the company in respect of debenture holders.

b.    Classification as per security

i.      Secured (or mortgaged) debentures: Debentures which are secured by a charge on the assets of the company are known as secured debentures. The charge may be fixed or floating.

ii.    Unsecured (or naked) debentures: Debentures which do not create any charge on the assets of the company are known as unsecured or naked debentures. The holders of these debentures are ranked at per with unsecured creditors in regard to their claims on the asset of the company.

c.     Classification as per repayment

i.      Redeemable debentures: These debentures are repayable after the specific period of time as per the terms of the issue.

ii.    Irredeemable (or perpetual) debentures: These debentures are not repayable during lifetime of the company. These are repaid at the time of liquidation. These are also called Perpetual Debentures.

d.    Classification as per convertibility

i.      Convertible debentures: These types of debenture may be converted into equity shares fully or partly after a certain period of time as per the terms of the company.

ii.    Non-convertible debentures: These debentures do not carry any right to convert them into preference or equity shares. They are repaid at maturity.

e.     On the basis of priority

i.      First debentures. Such debentures to be repaid in priority to other debentures.

ii.    Second debentures. Such debentures are to be repaid only after first debentures have been repaid in full.

28.3 Accounting Entries of Debentures

The Debentures should be made in the following ways:

i)      Cash issue of Debentures.

ii)     Installment wise Issue.

iii)    Issued for consideration other than cash.

iv)    Issued as Collateral security.

28.3.1 Cash issue of Debentures: Debenture may be issued (and also redeemed) at par, at premium or at a discount. The journal entries are as follows:

1. Issued and redeemable at par:
	Bank A/c	Dr.
	To Debenture A/c
2. Issued at a premium and redeemable at par:
	Bank A/c	Dr.
	To Debenture A/c
	To Premium on Issue of Debenture A/c
3. Issued at a discount and redeemable at par:
	Bank A/c	Dr.
	Discount on Issue of Debenture A/c	Dr.
	To Debenture A/c
4. Issued at par and redeemable at premium:
	Bank A/c	Dr.
	Loss on Issue of Debenture A/c	Dr.
	To Debenture A/c
	To Premium on Redemption of Debenture A/c
5. Issued at a discount and redeemable at premium:
	Bank A/c	Dr.
	Loss on Issue of Debenture A/c	Dr.
	To Debenture A/c
	To Premium on Redemption of Debenture A/c
Note: Loss on Issue of Debenture = Discount on issue + Premium on Redemption.
6. Issued at a premium and redeemable at a premium:
	Bank A/c	Dr.
	Loss on Issue of Debenture A/c	Dr.
	To Debenture A/c
	To Premium on Issue of Debenture A/c

The “Loss on issue of Debenture Account” and “Discount on issue of Debenture Account” appear under Misc. Expenses at the asset side of the Balance Sheet.

The “Premium on Redemption of Debenture” appears under Reserve & Surplus in the liabilities side of Balance Sheet.

Example :(Cash issue of Debentures)

Journalize the following transaction.

a.       Issue of 100 debentures of Rs.100 at a discount of 5% redeemable at par.

b.       Issue of 100 debentures of Rs.100 at a discount of 5% redeemable at a premium of 5%.

c.       Issue of 100 debentures of Rs.100 redeemable at a premium of 5%.

d.       Issue of 100 debentures of Rs.100 at a premium of 5% and redeemable at a premium of 5%.

Solution:

a.	Journal Entries		Dr.	Cr.
Date	Particulars		Rs.	Rs.
	Bank A/c	Dr.	9,500
	Discount on Issue of Debenture A/c (10,000 x5%)	Dr.	500
	To Debenture A/c			10,000
	(Issue of debentures at Rs.100 at a discount of 5% redeemable at par.)

Balance Sheet as on.... (Extract)

Liabilities	Rs.	Assets	Rs.
Secured Loan:		Bank	9,500
Debentures of Rs.100  each	10,000	Misc. Expenses:
		Discount on Issue of Debenture	500
	10,000		10,000

b.	Journal Entries		Dr.	Cr.
Date	Particulars		Rs.	Rs.
	Bank A/c	Dr.	9,500
	Discount on Issue of Debenture A/c (10,000x5%)	Dr.	500
	Loss on issue of Debenture A/c	Dr.	500
	To Debenture A/c			10,000
	To Premium on Redemption of Debenture A/c (10,000x5%)			500
	(Issue of debentures at Rs.100 at a discount of 5% redeemable at premium at 5%.)

Balance Sheet as on.... (Extract)

Liabilities	Rs.	Assets	Rs.
Secured Loan:		Bank	9,500
Debentures of Rs.100  each	10,000	Misc. Expenses:
Current Liabilities & Provision		Discount on Issue of Debenture	500
Premium on Redemption of Debenture	500	Loss on issue of Debenture	500
	10,500		10,500

c.	Journal Entries		Dr.	Cr.
Date	Particulars		Rs.	Rs.
	Bank A/c	Dr.	10,000
	Loss on issue of Debenture A/c	Dr.	500
	To Debenture A/c			10,000
	To Premium on Redemption of Debenture A/c (10,000x5%)			500
	(Issue of debentures of Rs.100 at par and redeemable at premium.)

Balance Sheet as on.... (Extract)

Liabilities	Rs.	Assets	Rs.
Secured Loan:		Bank	10,000
Debentures of Rs.100  each	10,000	Misc. Expenses:
Current Liabilities & Provision		Loss on issue of Debenture	500
Premium on Redemption of Debenture	500
	10,500		10,500

d.	Journal Entries		Dr.	Cr.
Date	Particulars		Rs.	Rs.
	Bank A/c	Dr.	10,500
	Loss on issue of Debenture A/c	Dr.	500
	To Debentures A/c			10,000
	To Premium on issue of Debenture A/c			500
	To Premium on Redemption of Debenture A/c (10,000x5%)			500
	(Issue of 100 debentures of Rs.100 at a premium of 5% and redeemable at a premium of 5 %.)

Balance Sheet as on.... (Extract)

Liabilities	Rs.	Assets	Rs.
Reserve & Surplus:		Bank	10,500
Premium on issue of Debenture	500	Misc. Expenses:
Secured Loan:		Loss on issue of Debenture	500
Debentures of Rs.100  each	10,000
Current Liabilities & Provision
Premium on Redemption of Debenture	500
	11,000		11,000

28.3.2 Installment wise Issue: Like issue of shares, money may be called in part, in various stages. Entries will be made similar to the issue of share.

1. When the application money is received:
	Bank A/c	Dr.
	To Debenture Application A/c
2. When the excess application money is refunded:
	Debenture Application A/c	Dr.
	To Bank
3. When the debentures are allotted:
	i) Issued at par Debenture Application A/c	Dr.
	To Debentures A/c
	Debenture Allotment A/c	Dr.
	To Debentures A/c
	ii) Issued at a discount Debenture Application A/c	Dr.
	To Debentures A/c
	Debenture Allotment A/c	Dr.
	Discount on Issue of Debenture A/c	Dr.
	To Debentures A/c
	iii) Issued at premium (Assuming prem.is paid on application.) Debenture Application A/c	Dr.
	To Debentures A/c
	To Premium on Issue of Debenture A/c
	Debenture Allotment A/c	Dr.
	To Debentures A/c
4. When allotment money is received:
	Bank A/c	Dr.
	To Debenture Allotment A/c
5. When call money is due:
	Debenture Call A/c	Dr.
	To Debentures A/c
6. When call money is received:
	Bank A/c	Dr.
	To Debenture Call A/c

Example: (Installment wise issue)

A ltd. issued 5,000, 14% Debentures of Rs.100 each at a premium of 10%, payable Rs.30 on application, Rs.50 on allotment (including premium) and the balance on call. Applications were received for 5,500 debentures. Excess applications were rejected. All moneys were duly received. Journalize the following transaction.

Solution:

		Journal Entries in the books of A Ltd.			Dr.	Cr.
S.L No.	Date	Particulars			Rs.	Rs.
1.		Bank A/c (5,500 x Rs.30)	Dr.		1,65,000
		To Debenture Application A/c				1,65,000
		(The application money received for 5,500 debentures of Rs.30 each.)
2.		Debenture Application A/c (500 x Rs.30)	Dr.		15,000
		To Bank A/c				15,000
		(The excess application money of 500 debentures of Rs.30 each refunded as per Board’s Resolution No… dated….)
3.		Debenture Application A/c (5,000 xRs.30)		Dr.	1,50,000
		To 14% Debenture A/c				1,50,000
		(The allotment of 5,000 debentures as per Board’s Resolution No… dated….)
4.		Debenture Allotment A/c		Dr.	2,50,000
		To 14% Debenture A/c (5,000 x Rs.40)				2,00,000
		To Debenture Premium A/c (5,000 x Rs.10)				50,000
		(The allotment money due on 5,000 debentures of Rs.40 each after adjusting premium as per Board’s Resolution No… dated….)
5.		Bank A/c	Dr.		2,00,000
		To Debenture Allotment A/c				2,00,000
		(The allotment money received in full.)
6.		Debenture Call A/c (5,000 x Rs.30)	Dr.		1,50,000
		To 14% Debenture A/c (Note)				1,50,000
		(The call money due on 5,000 debentures of Rs.30 each as per Board’s Resolution No… dated….)
7.		Bank A/c	Dr.		1,50,000
		To Debenture Call A/c				1,50,000
		(Final call received in full.)

Note: the debenture of Rs.100 is issued at a premium of Rs.10 (10%). So the amount payable on call is Rs.110- (30+50) = Rs.30 per debenture.

28.3.3 Debentures Issued for consideration other than cash: Debentures can be issued for consideration other than cash.

1. When purchase consideration becomes due:
	Sundry Asset A/c	Dr.
	To Sundry Liabilities A/c
	To Vendor A/c
2. When debenture is issued to satisfy the purchase consideration:
	Vendor A/c	Dr.
	To Debentures A/c

Example: The B Ltd. took over the asset of the A ltd. of Rs.3,00,000 and liabilities of Rs.1,50,000 for the purchase consideration of Rs.1,60,000. The B Ltd. settled the purchase consideration by issuing 12% debentures of Rs.100 each. Show the Journal entries.

Solution:

Working Notes:

1.     Net Assets taken over = (Assets – liabilities) i.e. (3,00,000 – 1,50,000) = Rs.1,50,000

Purchase Consideration = Rs.1,60,000

Excess amount of Rs.(1,60,000 - 1,50,000) = 10,000 will be treated as goodwill.

2.     No. of debentures to be issued = 1,60,000 / 100 = 1,600

	Journal Entries in the books of A Ltd.		Dr.	Cr.
Date	Particulars		Rs.	Rs.
	Sundry Asset A/c	Dr.	3,00,000
	Goodwill A/c [W.n.1]	Dr.	10,000
	To Sundry Liabilities A/c			1,50,000
	To B Ltd. A/c			1,60,000
	(The assets and liabilities taken over.)
	B Ltd. A/c	Dr.	1,60,000
	To 12% Debentures A/c			1,60,000
	(The issue of 12% debenture for settlement of purchase consideration.)

28.3.4 Debenture Issued as Collateral Security: Collateral Security means secondary or supporting security to bank or financial institution. Sometimes debenture may be issued to them as a collateral security for loan, on repayment of loan, debentures are released. If the loan is not repaid on due date, the lender becomes the debenture holder and can exercise all the rights of a debenture holder. Such holder does not receive any interest on debenture, but gets the interest on loan amount.

There are two methods for such issue.

Method 1: No entry will be made on such issue. Only reference is to be made in the Balance Sheet along with the loan amount.

Method 2: in this case following entry will be passed.

1. When debentures are issued as collateral security:
	Debenture Suspense A/c	Dr.
	To Debenture A/c
2. when the loan is repaid:
	Debenture A/c	Dr.
	To Debenture Suspense A/c

Note: From the accounting point of view Method 1 is more logical. Method 1 should be followed in this respect.

Example : A loan was obtained from a bank of Rs.15,00,000, giving a collateral security of Rs.20,00,000, 12% Debentures of Rs.100 each. How will it be treated?

Solution:

Method 1:

Balance Sheet as on....(Extract)

Liabilities	Rs.	Assets	Rs.
Secured Loan:
Bank loan	15,00,000
(Secured by issue of Rs.20,00,000, 12% Debentures of Rs.100 each.)

Method 2:

	Journal Entries		Dr.	Cr.
Date	Particulars		Rs.	Rs.
	Debenture Suspense A/c	Dr.	20,00,000
	To 12% Debentures A/c (the issue of 12% debenture of Rs.20,00,000 collaterally secured as per board’s resolution No…. dated…)			20,00,000

Balance Sheet as on.... (Extract)

Liabilities	Rs.	Assets	Rs.
Secured Loan:		Debenture Suspense Account	20,00,000
Bank loan	15,00,000
12% Debentures	20,00,000

28.4 Discounts on Issue of Debentures

i)    If the debentures are issued at a discount, or redeemable at a premium, such discount or premium represents capital loss and should be written off.

ii)   The following journal entry will be passed to write off the discount.

Profit & Loss A/c	Dr.
To Discount on Issue of Debenture A/c

Remaining balance will be shown on the asset side of the debenture under miscellaneous expenses.

iii)  If the debentures are redeemed after a certain period of time, the total amount of discount should be written off equally over the period after which the debenture will be redeemed.

Equal amount of discount to be written off annually = Total Discount / No. of years of redemption of debenture

iv)  When debentures are redeemed by unequal instalment, then the total amount of issue of debentures should be written off in the ratio in which the amount of debentures has been used each year.

v)   If the debentures are irredeemable, the discount should be written off gradually over a long period.

Example: N Ltd. issued 12% 4,000 debentures of Rs.100 each at a discount of 10% redeemable at par after 5 years. Show the discount on issue of debentures account for these years if the equal amount of discount is to be written off every year.

Solution:

Total discount allowed on issue of debentures = (Rs.4,000 x Rs.100) x 10/100 = Rs.40,000.

Since the debentures are to be redeemed after 5 years, the equal amount of discount to be charged to revenue each year is 40,000/5 = Rs.8,000.

Books of N Ltd.

Discount on issue of Debentures A/c

Dr.					Cr.
Date	Particulars	Rs.	Date	Particulars	Rs.
Beginning	To 12% Debentures A/c	40,000	Ending	By Profit & Loss A/c	8,000
1st year			1st year	By Balance c/d	32,000
		40,000			40,000
2nd year	To Balance b/d	32,000	2nd year	By P & L A/c	8,000
				By Balance c/d	24,000
		32,000			32,000
3rd year	To Balance b/d	24,000	3rd year	By P & L A/c	8,000
				By Balance c/d	16,000
		24,000			24,000
4th year	To Balance b/d	16,000	4th year	By P & L A/c	8,000
				By Balance c/d	8,000
		16,000			16,000
5th year	To Balance b/d	8,000	5th year	By P & L A/c	8,000
		8,000			8,000

28.5 Debenture Stock

Debenture stock is a document issued by a company, for securiting a large amount of loan. A single document is issued instead of issuing a number of debentures. It can be issued at any amount and may include fraction amount.

28.6 Debenture Interest

Company has to pay interest on debentures at a specified rate at regular interval (normally sixth months). Interest is payable on nominal value of the debentures and charged against profit and debited to Profit & Loss Account.

As per the Income Tax Act, 1956, a company is also required to deduct tax at source (TDS), at a prescribed rate, before the payment of interest on debenture. The journal entries will be as follows:

1. When interest on debenture is payable:
	Interest on Debenture A/c (total interest)	Dr.
	To Debenture holders A/c (net interest)
	To Tax Deducted at source A/c (TDS)
2. When the net interest on debenture is paid:
	Debenture holders A/c	Dr.
	To Bank
3. On transferring to Profit & Loss Account:
	Profit & Loss A/c	Dr.
	To Interest on Debenture A/c
4. Outstanding interest on debenture:
	Interest on Debenture A/c	Dr.
	To Outstanding Interest on Debenture A/c
5. On payment of TDS
	Tax Deducted at source A/c	Dr.
	To Bank A/c

Example:

A ltd. issued 5,000, 14% Debentures of Rs.100 each on 1^st January, 2009. Interest is payable yearly on 31^st December, 2009.

Show the necessary journal entries relating to debenture interest for the year ended 31^st December, 2009 assuming that all money was duly paid by the company and tax deducted at source on debenture interest rate is 10%.

Solution:

	Journal Entries in the Books of A Ltd.		Dr.	Cr.
Date	Particulars		Rs.	Rs.
31.12.09	Interest on Debenture A/c (5,000 x Rs.100 x 14%)	Dr.	70,000
	To Debenture holders A/c			63,000
	To Tax Deducted at source A/c (70,000 x 10%)			7,000
	(Interest due on debentures annually and tax deducted at source at 10% p.a.)
”	Debenture holders A/c	Dr.	63,000
	To Bank A/c			63,000
	(Payment of interest to debenture holders.)
”	Tax Deducted at source A/c	Dr.	7,000
	To Bank A/c			7,000
	(Deposit of tax deducted at source from debenture interest.)
”	Profit & Loss A/c	Dr.	63,000
	To Interest on Debenture A/c			63,000
	(Transfer of Interest on Debenture to Profit & Loss A/c.)