Company Accounts - Issue of Debentures

 

Company Accounts

Issue of Debentures

 

  After studying this article, you will be able to:

1	Understand the meaning and basic purpose of issuing debentures by the company
2	Know the important features of a debenture
3	Pass journal entries for issue of debentures considering the condition of redemption
4	Understand the accounting treatments for issue of debentures as collateral security
5	Pass journal entries for issue of debentures in consideration other than for cash
6	Write-off discount on issue of debentures
7	Pass journal entries for interest on debentures

 

 

Moreover, in this article you will find five solved illustrations explaining different aspects related to the issue of debentures.

 

 

Introduction

In the case of a limited company, debenture is the most common form of loan capital which is made available by the investors on a long term basis. When a company borrows money from its investors, it issues certificates which are stamped with the official seal of the company. These certificates are called “Debentures”. Debenture is a document containing details of a fixed interest-bearing loan taken by a company from an investor. Thus, a debenture is a document which evidences a loan. In other words, a debenture is a bond issued by a company under its seal, acknowledging a debt and containing provisions as regards repayment of the principal and interest.

 

  Important features of a debenture are:

1	It is a document which evidences a loan made to a company.
2	It is a fixed interest-bearing security where interest falls due on specific dates (usually, twice an accounting year).
3	Interest is payable at a predetermined fixed rate per annum, regardless of the level of profit.
4	The original sum is repaid at a specified future date or it is converted into shares or other debentures.
5	It may or may not create a charge on the assets of the company as security.
6	It can generally be bought or sold through the stock exchanges at a market price which may be above or below its face value.
7	Under Section 44 of The Companies Act, 2013 it is a movable property transferable in the manner provided by the articles of the company.
8	Under Section 71 of The Companies Act, 2013 no company can issue any debentures carrying any voting rights.

 

Face value (also known as Nominal Value)

It is the value of debentures which is written on the face of a debenture certificate and on which value is calculated the debenture interest by applying the percentage of debenture interest.

 

 

Issue price

It is the price at which debentures are issued by a company to the public. Debentures may be issued to the public at a premium, at a discount or at par. Issue price under different situations are as follows:

a)        When issued at a premium –

       Issue price = face value + premium.

b)        When issued at a discount –

       Issue price = face value – discount.

c)         When issued at par –

       Issue price = face value.

 

Journal entries for issue of redeemable debentures:

The issue of redeemable debentures can be categorised into the following:

1	Debentures issued at par and redeemable at par
2	Debentures issued at a discount and redeemable at par
3	Debentures issued at premium and redeemable at par
4	Debentures issued at par and redeemable at premium
5	Debentures issued at a discount and redeemable at premium
6	Debentures issued at premium and redeemable at premium

 

Note: Redemption at a discount is a rare circumstance in practical life.

Journal entries

1. Debentures issued at par and redeemable at par:

	Particulars		Dr (Rs)	Cr (Rs)
1	For receipt of application money:
	Bank A/c	Dr
	To Debenture application A/c
2	For transfer of application money to debentures a/c:
	Debenture application A/c	Dr
	To ...% Debenture A/c

 

2. Debentures issued at discount and redeemable at par:

	Particulars		Dr (Rs)	Cr (Rs)
1	For receipt of application money:
	Bank A/c	Dr
	To Debenture application A/c
2	For transfer of application money to debentures a/c at the time of making allotment:
	Debenture application A/c	Dr
	Discount on issue of debentures A/c	Dr
	To ...% Debenture A/c

 

3. Debentures issued at premium and redeemable at par:

	Particulars		Dr (Rs)	Cr (Rs)
1	For receipt of application money:
	Bank A/c	Dr
	To Debenture application A/c
2	For transfer of application money to debentures a/c at the time of making allotment:
	Debenture application A/c	Dr
	To ...% Debenture A/c
	To Securities premium A/c

 

4. Debentures issued at par and redeemable at premium:

	Particulars		Dr (Rs)	Cr (Rs)
1	For receipt of application money:
	Bank A/c	Dr
	To Debenture application A/c
2	For transfer of application money to debentures a/c at the time of making allotment:
	Debenture application A/c	Dr
	To ...% Debenture A/c
3	For making a provision for future loss due to redemption of the debentures at a premium:
	Loss on issue of debentures A/c	Dr
	To Premium on redemption of debenture A/c

 

5. Debentures issued at discount and redeemable at premium:

	Particulars		Dr (Rs)	Cr (Rs)
1	For receipt of application money:
	Bank A/c	Dr
	To Debenture application A/c
2	For transfer of application money to debentures a/c at the time of making allotment:
	Debenture application A/c	Dr
	Discount on issue of debentures A/c	Dr
	To ...% Debenture A/c
3	For making a provision for future loss due to redemption of the debentures at a premium:
	Loss on issue of debentures A/c	Dr
	To Premium on redemption of debentures A/c

 

6. Debentures issued at premium and redeemable at premium:

	Particulars		Dr (Rs)	Cr (Rs)
1	For receipt of application money:
	Bank A/c	Dr
	To Debenture application A/c
2	For transfer of application money to debentures a/c at the time of making allotment:
	Debenture application A/c	Dr
	To ...% Debenture A/c
	To Securities premium A/c
3	For making a provision for future loss due to redemption of the debentures at a premium:
	Loss on issue of debentures A/c	Dr
	To Premium on redemption of debenture A/c

 

Note:

Premium on the redemption of debentures is to be recorded under the head: Non Current Liabilities and subhead: Long Term Borrowings.

 

 

Write off of total of discount on issue of debentures and loss on issue of debentures – different methods

 

1^st Method – When debentures are redeemable all at a time at the end of the Maturity/redemption period

Under this method, the total of discount on issue of debentures and loss on issue of debentures is written off by debiting profit and loss account an equal amount every year throughout the maturity period of the debentures.

Journal entry:

	Particulars		Dr (Rs)	Cr (Rs)
1	Profit and loss A/c	Dr
	To Loss on issue of debentures A/c

 

Illustration: 1

On 1^st January, 2018 a company issued 1, 00,000 12% debentures redeemable after 5 years. Debentures were issued at a discount of 6%. Find out the amount to be charged every year to profit and loss account to write off the discount on issue of debentures. Also show the discount on issue of debentures account for 5 years from the year 2018 to 2022.

 

2^nd Method – When debentures are redeemable every year by equal amount thereby redeeming all the debentures throughout the redemption period

Under this method, the total of discount on issue of debentures and loss on issue of debentures to be charged to profit and loss account will be calculated by sum-of-years’-digits (SYD) method.

 

Illustration: 2

On 01-01-2018 a company issued 1, 00,000 12% debentures at 6% discount, redeemable Rs 20,00,000 every year starting from 31-12-2018 at a premium of 6%. Make journal entries at the time of issue of the debentures and prepare loss on issue of debentures account for 5 years from the year 2018 to 2022.

 

3^rd Method – When debentures are redeemable at different times of the redemption period for different amounts following no particular pattern

Under this method, the total of discount on issue of debentures and loss on issue of debentures to be charged to profit and loss account will be calculated by ratio of utilized value (RUV) method.

 

Illustration: 3

On 1^st January, 2008 a company issued 1, 00,000 12% debentures at 6% discount redeemable at 10.5% premium in the following manner:

(a) Rs 40, 00,000 to be redeemed at the end of 2^nd year,

(b) Rs 10, 00,000 to be redeemed at the end of 3^rd year,

(c) Rs 30, 00,000 to be redeemed at the end of 4^th year,

(d) Rs 20, 00,000 to be redeemed at the end of 5^th year.

 

Make journal entries at the time of issue of the debentures and prepare loss on issue of debentures account for 5 years from the year 2008 to 2012.

 

Issue of Debentures as Collateral Security

 

Collateral security is a form of secondary protection sometimes required by a bank and intended to guarantee a borrower’s performance on a debt obligation. The primary security on a substantial business loan is typically the thing that is being financed, such as a factory, company car or shipment, but secondary or collateral security might also be requested by a bank to help assure that the loan will be repaid.

 

When the lender feels, the security provided by the borrower is not sufficient or it may be difficult to recover the dues smoothly, the lender may ask for additional security to be provided by the borrower himself or other on behalf of the borrower. In case of any dispute or failure to discharge the loan by the borrower, the collateral securities will come in hand to service and recover the loan/debt.

 

 

Sometimes companies issue their own debentures as collateral security for a loan. When the loan is repaid on the due date, these debentures are at once released with the main security. In case, the company cannot repay its loan and the interest thereon on the due date, the lender becomes the debenture holder who can exercise all the rights of a debenture holder. The holder of such debentures is entitled to interest only on the amount of loan, but not on the debentures.

 

Accounting Treatment:

There are two methods of accounting for issue of debentures as a collateral security.

 

FIRST METHOD

Journal entries:

	Particulars		Dr (Rs)	Cr (Rs)
1	For bank loan received:
	Bank A/c	Dr
	To Bank loan A/c

 

Under this method no journal entry is passed in the books of account for issuing debentures to the bank as collateral security. It is disclosed under the head Secured Loans on the Equity and Liabilities part of the Balance Sheet as follows:

 

Balance Sheet (Extract) as at………………………

Particulars	Note No.	Rs
Equity and Liabilities:
Non-Current Liabilities:
Long-term borrowings	1	×××

 

Notes to Accounts:

Particulars	Rs
1. Long-term borrowings:
Secured Loan:
Bank loan (Collaterally secured by the issue of ....% Debentures of Rs 100 each)	×××

 

SECOND METHOD

Journal entries:

Under this method following two journal entries are made in the books of the company taking the bank loan:

	Particulars		Dr (Rs)	Cr (Rs)
1	For bank loan received:
	Bank A/c	Dr
	To Bank loan A/c
2	For issuing debentures to the bank as collateral security:
	Debentures Suspense A/c	Dr
	To ...% Debenture A/c

 

 

Balance Sheet (Extract) as at………………………

Particulars	Note No.	Rs
Equity and Liabilities:
Non-Current Liabilities:
Long-term borrowings	1	×××

    

Notes to Accounts:

Particulars	Rs
1.          Long-term borrowings:
Bank loan	×××
....% Debentures (For debenture issued to bank as collateral security)               ×××
LESS: Debentures Suspense Account  (For debentures issued as collateral)      ×××	Nil
	×××

 

 

Issue of debentures other than for cash

 

Issue of debentures to promoters

A company may allot debentures to the promoters of the company for providing their services.

 

Journal entries:

	Particulars		Dr (Rs)	Cr (Rs)
1	For cost of incorporation of the company paid to the promoters by issue of debentures:
	Goodwill A/c	Dr
	To Promoters’ A/c
2	For allotment of debentures to the promoters:
	Promoters’ A/c	Dr
	To Debentures A/c

 

 

Issue of debentures to underwriters

A company may allot debentures to the underwriters to pay their underwriting commission.

 

Journal entries:

	Particulars		Dr (Rs)	Cr (Rs)
1	For underwriting commission becoming due:
	Underwriting Commission A/c	Dr
	To Underwriters’ A/c
2	For allotment of debentures to the underwriters:
	Underwriters’ A/c	Dr
	To Debentures A/c
3	For writing off underwriting commission:
	Securities Premium A/c (If Securities Premium exists in B/S)	Dr
	Statement of Profit and Loss A/c	Dr
	To Underwriting Commission A/c

 

 

Issue of debentures to vendors

Just like shares, debentures can also be issued to vendors against purchase of assets like land, building, plant, equipment, etc or even against purchase of an entire business.

 

Journal entries:

	Particulars		Dr (Rs)	Cr (Rs)
1	For assets and liabilities taken over:
	A. When Purchase consideration = Net asset taken over
	Sundry assets A/c (Value of assets taken over)	Dr
	To Sundry liabilities A/c       (Value of liabilities taken      over)
	To Vendors A/c       (Purchase consideration)
	B. When Purchase consideration > Net asset taken over
	Sundry assets A/c (Value of assets taken over)	Dr
	Goodwill A/c (Purchase Consideration − Net Asset)	Dr
	To Sundry liabilities A/c       (Value of liabilities taken      over)
	To Vendors A/c       (Purchase consideration)
	C. When Purchase consideration < Net asset taken over
	Sundry assets A/c (Value of assets taken over)	Dr
	To Sundry liabilities A/c       (Value of liabilities taken      over)
	To Capital Reserve A/c       (Net Asset − Purchase Consideration)
	To Vendors A/c       (Purchase consideration)
2	For issue of debentures (at par) to the vendor to satisfy the purchase consideration:
	Vendors A/c (Purchase consideration)	Dr
	To Debentures A/c       (Face value of debentures issued)
3	For issue of debentures (at discount) to the vendor to satisfy the purchase consideration:
	Vendors A/c (Purchase consideration)	Dr
	Discount on issue of debentures A/c (Discount on issue of debentures)	Dr
	To Debentures A/c       (Face value of debentures issued)
4	For issue of debentures (at premium) to the vendor to satisfy the purchase consideration:
	Vendors A/c (Purchase consideration)	Dr
	To Debentures A/c       (Face value of debentures issued)
	To Securities premium A/c       (Premium on issue of debentures)

 

 

Illustration: 4

On 1^st January, 2018 a machine is purchased by a company for Rs 14, 35,740. Payment for the same is made as follows: (i) Rs 3, 00,000 paid in cash, and (ii) for the balance, 12% debentures were issued at 8% discount. Pass necessary journal entries and also show the number of debentures issued.

 

Illustration: 5

On 1^st January, 2018 a machine is purchased by a company for Rs 15, 08,570. Payment for the same is made as follows: (i) Rs 2, 00,000 paid in cash and (ii) for the balance, 12% debentures were issued at 6% premium. Pass necessary journal entries and also show the number of debentures issued.

 

Debenture Interest

 

The rate percentage of debenture interest is typically expressed on per annum basis. Debenture interest is payable at regular intervals at a fixed rate percentage of the face value of the debentures. It is a charge against the profits of the company and it is payable to the debenture holders whether profits are earned or not by the company. As per the provisions of the Income Tax Act, 1961, a company is required to deduct tax at source, at the prescribed rate, before payment of debenture interest to the debenture holders. The companies will deposit the tax so deducted with the income tax authorities.

 

Journal entries:

	Particulars		Dr (Rs)	Cr (Rs)
1	For making interest due:
	Debenture interest A/c	Dr
	To Debenture holders’ A/c
2	For making payment of interest after deduction of tax at source:
	Debenture holders’ A/c	Dr
	To TDS Payable A/c
	To Bank A/c
3	For making payment of TDS to the income tax authorities:
	TDS Payable A/c	Dr
	To Bank A/c
4	For transferring debenture interest to profit and loss account
	Profit and loss A/c	Dr
	To Debenture interest A/c