DEBENTURES

You have learnt that share capital is the main

source of finance of a joint
stock company. Such capital is raised by issuing
shares. Those who hold
the shares of the company are called the
shareholders and are owners of
the company. Company may need additional
amount of money for a long
period. It cannot issue shares every time. It can
raise loan from the public.
The amount of loan can be divided into units of
small denominations and
the company can sell them to the public. Each unit
is called a ‘debenture’
and holder of such units is called Debenture
holder. The amount so raised
is loan for the company. In this lesson we shall
learn about issue of
debentures and its accounting treatment.

1.OBJECTIVES

After studying this lesson you will be able to :

_ state the meaning and types of debentures;
_ explain the procedure of issue of debentures and
its accounting
treatment;
_ explain issue of debentures as collateral security;
_ explain ‘writing off discount’ and ‘loss on issue
debentures’ and their
accounting treatment in the books of the company;
_ calculate interest on debentures.
2.Debentures And Its Types
A Debenture is a unit of loan amount. When a
company intends to raise
the loan amount from the public it issues
debentures. A person holding
debenture or debentures is called a debenture
holder. A debenture is adocument issued under the
seal of the company. It is an acknowledgment
of the loan received by the company equal to the
nominal value of thedebenture. It bears the date of
redemption and rate and mode of payment of
interest. A debenture holder is the creditor of the
company.
As per section 2(12) of Companies Act 1956,
“Debenture includes debenture stock, bond and
any other securities of the company whether
constituting a charge on the company’s assets or
not”.
Types of debentures
Debenture can be classified as under :
1. From security point of view
(i) Secured or Mortgage debentures : These are
the debentures that are secured by a charge on the
assets of the company. These are also called
mortgage debentures. The holders of secured
debentures have the right to recover their principal
amount with the unpaid amount of interest on such
debentures out of the assets mortgaged by the
company. In India, debentures must be secured.
Secured debentures can be of two types :
(a) First mortgage debentures : The holders of such
debentures have a first claim on the assets charged.
(b) Second mortgage debentures : The holders of
such debentures have a second claim on the assets
charged.
(ii) Unsecured debentures : Debentures which do
not carry any security with regard to the principal
amount or unpaid interest are called unsecured
debentures. These are called simple debentures.
2. On the basis of redemption
(i) Redeemable debentures : These are the
debentures which are issued for a fixed period.
The principal amount of such debentures is paid
off to the debenture holders on the expiry of such
period. These can be redeemed by annual drawings
or by purchasing from the open market.
(ii) Non-redeemable debentures : These are the
debentures which are not redeemed in the life time
of the company. Such debentures are paid back
only when the company goes into liquidation.
3. On the basis of Records
(i) Registered debentures : These are the
debentures that are registered with the company.
The amount of such debentures is payable only to
those debenture holders whose name appears in
the register of the company.
(ii) Bearer debentures : These are the debentures
which are not recorded in a register of the
company. Such debentures are transferrable
merely by delivery. Holder of these debentures is
entitled to get the interest.
4. On the basis of convertibility
(i) Convertible debentures : These are the
debentures that can be converted into shares of the
company on the expiry of predecided period. The
term and conditions of conversion are generally
announced at the time of issue of debentures.
(ii) Non-convertible debentures : The debenture
holders of such debentures cannot convert their
debentures into shares of the company.
5. On the basis of priority
(i) First debentures : These debentures are
redeemed before other debentures.
(ii) Second debentures : These debentures are
redeemed after the redemption of first debentures.
ISSUE OF DEBENTURES
By issuing debentures means issue of a certificate
by the company under its seal which is an
acknowledgment of debt taken by the company.
The procedure of issue of debentures by a
company is similar to that of the issue of shares. A
Prospectus is issued, applications are invited, and
letters of allotment are issued. On rejection of
applications, application money is refunded. In
case of partial allotment, excess application money
may be adjusted towards subsequent calls.
Issue of Debenture takes various forms which are
as under :
1. Debentures issued for cash
2. Debentures issued for consideration other than
cash
3. Debentures issued as collateral security.
Further, debentures may be issued
(i) at par, (ii) at premium, and (iii) at discount
Accounting treatment of issue of debentures for
cash
1. Debentures issued for cash at par :
Following journal entries will be made :
(i) Application money is received
Bank A/c Dr
To Debentures Application A/c
(Application money received for Debentures)
(ii) Transfer of debentures application money to
debentures account
on their allotment
Debentures Application A/c Dr
To Debentures A/c
(Application money transferred to debenture
account on allotment)
(iii) Money due on allotment
Debentures Allotment A/c Dr
To Debentures A/c
(Allotment money made due)
(iv) Money due on allotment is received
Bank A/c Dr
To Debentures Allotment A/c
(Receipt of Debenture allotment money)
(v) First and final call is made
Debentures First and Final call A/c Dr
To Debentures A/c
(First and Final call money made due on ...............
debentures)
(vi) Debentures First and Final call money is
received
Bank A/c Dr
To Debentures First and Final call A/c
(Receipt of Amount due on call)
Note : Two calls i.e. first call and second call may
be made
Journal entries will be made on the lines made for
first and final call.
Illustration 1
Shining India Ltd. issued 5000 8% Debentures of
Rs 100 each payable as
follows
Rs 20 on Application
Rs 30 on Allotment
Rs. 50 on First and Final call
All the debentures were applied for and allotted.
All the calls were duly
received. Make necessary journal entries in the
books of the company.
Solution :
Shining India Ltd.

S.No. Particulars LF Amount Amount

1. Bank A/c ... Dr 100000

To Debentures Application A/c 100000
 (Application money received for
5000 debentures)
2. Debentures Application A/c Dr 100000
To 8% Debentures A/c 100000
(Application money transferred to
Debentures A/c on allotment)
3. Debentures Allotment a/c Dr 150000
To 8% Debentures A/c 150000
(Allotment money due on 5000
debentures @ Rs 30 per debenture)
4. Bank A/c Dr 150000
To Debentures Allotment A/c 150000
(Allotment money received)
5. Debentures First and Final call A/cDr 250000
To 8% Debentures A/c 250000
(Debentures first and final call money
made due @ Rs 50 per debenture)
6. Bank A/c Dr 250000
To Debentures First and Final call A/c 250000
(Receipt of Debentures first and final
call money)
Over subscription
Company if receives applications for number of
debentures that exceed the
number of debentures offered for subscription, it is
called over subscription.
There can be following treatment of the excess
application money
received :
(a) The total amount of excess number of
applications is refunded in case the applications
are totally rejected.
(b) The amount of excess application money is
totally adjusted towards amount due on allotment
and calls
— in case partial allotment is made,
— the excess amount is adjusted towards sums due
on allotment and rest of the amount is refunded.
Journal entries in the above cases will be as
follows :
For refund of money if the applications are
rejected
Debentures Application A/c Dr
To Bank A/c
(Refund of money on rejected applications)
For adjustment of excess application money
adjusted towards sum due on
allotment
Debentures Application A/c Dr
To Debentures Allotment A/c
(Excess application money adjusted)
 ISSUE OF DEBENTURES AS COLLATERAL
SECURITY
Collateral security means security given in
addition to the principal security. It is a subsidiary
or secondary security. Whenever a company takes
loan from bank or any financial institution it may
issue its debentures as secondary security which is
in addition to the principal security. Such an
issue of debentures is known as ‘issue of
debentures as collateral security’.
The lender will have a right over such debentures
only when company fails to pay the loan amount
and the principal security is exhausted. In case the
need to exercise this right does not arise
debentures will be returned back to the company.
No interest is paid on the debentures issued as
collateral security because company pays interest
on loan. In the accounting books of the company
issue of debentures as collateral security can be
credited in two ways.
(i) No journal entry to be made in the books of
accounts of the company :
Debentures are issued as collateral security. A note
of this fact is given on the liability side of the
balance sheet under the heading Secured Loans
and Advances.
(ii) Entry to be made in the books of account
the company
A journal entry is made on the issue of debentures
as a collateral security, Debentures suspense A/c is
debited because no cash is received for such issue.

Following journal entry will be made

Debenture Suspense A/c Dr
To Debentures A/c
(.....Debentures of Rs .... each issued as
collateral security to .....)
DISCOUNT ON ISSUE OF DEBENTURES
AND LOSS ON ISSUE OF DEBENTURES
In case company issues debentures on discount the
total amount of discount is not charged to profit
and Loss Account of the company in the
accounting year in which this discount is allowed.
The amount of such discount is very heavy and to
the company gets benefit from the loan by issuing
debentures over a number of years. Hence some
part of the amount of discount is written off every
year. Generally it is written off prior to the
redemption of these debentures. As the amount of
discount on issue of debentures is treated as a
capital loss, it is shown on the asset side of the
balance sheet of the company under the head
“Miscellaneous Expenditure” until and by the
amount it is not written off.
The amount of debenture discount can be
written off in two ways :
1. All debentures are to be redeemed after a
fixed period.
When the debentures are to be redeemed after a
fixed period, the amount of discount will be
distributed equally within the number of years
spreaded between the issue of debentures and their
redemption. The amount of discount on issue of
debentures to be written off each year is calculated
as
Amount of discount to be written off annually
=
Total amount of Discount
Number of years
Illustration 8
A company issues 1000 debentures of Rs 1000
each at a discount of 10%
for a period of 5 years i.e. to be redeemed after 5
years. Calculate the amount
of discount to be written off each year and prepare
on issue of debentures
discount account.
Solution
Amount of discount = (1000 Rs1000) 10/100
= Rs 100000
Amount to be written off each year = Rs 20000
2. Debentures are redeemed in instalments
Debentures may also be redeemed in instalments
but over a fixed period. In that case the amount of
debenture discount will be written off each year in
proportion to the amount of debentures redeemed.
Loss on Issue of Debentures
You have learnt that a company may issue
debentures with the stipulation that the repayment
of the debentures on maturity will be made at
premium. The amount of the premium payable is
debited to Loss on Issue of Debentures A/c at the
time of issue of debentures. This amount will also
be written off in the same manner as is done in
case of writing off Discount on Issue of
Debentures. This is illustrated as under :
(i) All Debentures are redeemed after fixed
period
Journal Entry
Amount of Loss on Issue of Debentures written off
each year
Profit and Loss A/c Dr
To Loss on Issue of Debentures A/c
(Loss on Issue of Debentures written off)
Same journal entry will be made each year till the
whole amount of the Loss on issue of Debentures
is written off.
Interest on Debentures
If you have seen an advertisement in newspaper
regarding issue of debentures by a company, you
must have noticed that ‘Debenture’ is always
prefixed by a certain percentage say 9%
Debentures or 12% Debentures. Have you ever
thought what meaning does this prefix carry. It is
the rate of interest per annum that will be paid to
the debenture holders. Companies generally pay
interest on its debentures after every six months.
Journal entries that are made in the books of the
company are as follows;
(i) Payment of Interest on Debentures
Debenture Interest A/c Dr
To Bank A/c
(Interest on ....% Debentures paid for six months
ending ...@ ....% pa)
(ii) Transfer of Debenture Interest to Profit and
Loss A/c
Profit and Loss A/c Dr
To Debenture Interest A/c
(Debenture Interest transferred to Profit and Loss
A/c)
Debentures can be classified on the basis of :
_ Issue of debentures : Debentures can be issued
for cash at par, for
consideration other than cash, as collateral security
debentures are said
to be oversubscribed when the company receives
application for number
of debentures than the company has offered for
subscription.
Debenture can be issued at premium, at discount
and in consideration
other than cash.
_ Debentures can be issued with conditions
stipulated to their redemption as :
1.Issued at par redeemable at par
2.Issued at discount redeemable at par
3.Issued at premium redeemable at par
4.Issued at par redeemable at premium
5.Issued at discount redeemable at premium
6. Issue of debentures as collateral security means
issuing debentures to the lending agency that has
given loan as additional/secondary security.