CBSE Class XII Accounts Fundamental Concepts

Chapter 7

Company Accounts - Debentures

Meaning of debentures

Debentures are debt instruments issued by a joint stock company. Amounts collected by way of debentures form part of the loan capital of a company. They are repayable after a fixed period. Debentures are issued in units of small value for convenient buying and selling in the market. Debenture holders get interest on their debenture. They are creditors of the company. They do not get dividend. Only shareholders get dividend.

According to S.2 (12) of the companies Act, 1956, debentures include “debenture stock, bonds and any other securities of a company”. The basic difference between debentures and bonds is that the debentures are usually secured. Unlike debentures bonds can be floated with a fixed interest or floating interest rate. They can also be issued without interest as discount bonds. Discount bonds are issued at a discount on the face value. The investor gets full amount on redemption of debenture. From the point of view of investor, bonds are instruments carrying higher risks and higher rates of returns compared to debentures.

The characteristics of debentures can be summarised as follows:

1.      Debentures are debt instruments.

2.      They generally carry fixed rate of interest.

3.      They are normally repayable at the end of a fixed period. Repayment of debenture or cancellation of debenture liability in the books of the company is known as redemption of debentures.

4.      They can be issued at par, premium or at discount depending on the reputation of the company.

5.      They can either be placed privately or offered for public subscription.

6.      They may or may not be listed in the stock exchange.

7.      If offered for public subscription, they should be rated by a credit rating agency approved by SEBI, prior to listing.

8.      Interest is payable on debentures at a fixed rate irrespective of the profit earned by the business.

9.      Debentures may be issued with or without the security of assets of the company.

10.  In the event of winding up of the company the debenture holders are treated as creditors and given priority in repayment of their money.

11.  Debenture holders normally do not have representation in the Board of the company.

Distinction between Shares and Debentures

Types of Debentures

Debentures are classified as follows:

1. On the Basis of Repayment:

a. Redeemable Debentures

These debentures are paid off or redeemed after the prescribed period.

b. Irredeemable or Perpetual Debentures

These debentures are permanent debentures of a company. They are paid back only in the event of winding up of a company.

2. On the Basis of Transferability:

a. Registered Debentures

These are debentures for which the company maintains record of debenture holders. Therefore when such debentures are sold or transferred it should be intimated to the company for making change in the register of debenture holders.

b. Bearer Debentures

These debentures are transferable by mere delivery. There is no need or registration of transfer with the company.

3. On the Basis of Security:

a. Simple or Naked Debentures

These are debentures not secured by any asset of the company. If the company goes into liquidation these debentures are treated as unsecured creditors.

b. Mortgage Debentures

Mortgage debentures are issued on the security of certain assets of the company. They can be secured by fixed assets or floating assets of the company. If the debentures are secured by a fixed charge on assets, the company cannot sell or exchange the assets without paying off the debentures. However in case of floating charge, the company can buy or sell the assets involved until the winding up procedures are initiated or the debenture holders exercise their right to ‘crystallise’ the claim.

4. On the basis of Conversion:

a. Convertible Debentures

These debentures are issued with an option to debenture holders to convert them into shares after a fixed period. Convertible debentures are either partially convertible debentures or fully convertible debentures. In case of partially convertible debentures part of the instrument is redeemed and part of it is converted into shares.

In case of fully convertible debentures the full value of the debenture is converted into equity. Convertible debentures are generally issued to prevent sudden outflow of the capital at the time of maturity of the instrument, which may cause liquidity problems. The conversion ratio, which is the number of equity shares exchanged per unit of the convertible debenture is clearly stated when the instrument is issued.

b. Non Convertible Debentures

These are debentures issued without conversion option. The total amount of the debenture will be redeemed by the issuing company at the end of the specific period.

5. On the Basis of Pre-Mature Redemption Rights:

a. Debenture with “Call” option

A callable debenture is one in which the issuing company has the option of redeeming the security before the specified redemption date at a pre-determined price.

b. Debenture with “Put” option

This is a debenture in which the holder has the option of getting it redeemed before maturity.

6. On the Basis of Coupon Rate (interest rate):

a. Fixed Rate Debentures

Most of the time debentures are issued with a prefixed rate interest. These debentures are called fixed interest debentures

b. Floating rate Debentures

Floating rate as the names suggests keeps changing. It is usually linked with PLR (prime lending rate). It may add a risk premium to PLR on debenture. Thus PLR + 50 “basis points” and if the PLR is 11 percent, debenture interest rate will be 11.5 percent.

c. Zero Coupon Bonds

These are debentures issued with no interest specified. They are issued at a substantial discount to compensate the investors. These bonds are known as deep discount bonds. The difference between the face value and the issue price is the total amount of interest for the duration of the bond. From the account point of view this discount is recorded as “Deferred Interest Expense Account” at the time of issue bonds and proportionate amounts are written off each year over the life of the bond.

Issue of Debentures

Like shares debentures can also be issued at par, premium or discount. Collection of money also can be made in installments. Debentures can be issued for cash or consideration other than cash.

Journal Entries for the issue of debentures are similar to that of shares. In comparison with issue of shares, all temporary accounts for issue of debentures bear the prefix ‘debenture’ instead of share, such as debenture application, debenture allotment, debenture 1^st call etc. Share capital account on the credit side of the journal entry is replaced by Debenture Account bearing a prefix indicating the rate of interest.

Journal Entries for the issue of Debentures

Journal entries for the issue of debentures will vary according to the conditions of issue and the conditions of redemption. Debentures can be issued at par, premium or discount. Similarly the debentures can be redeemed at par, premium or discount. Thus there can be nine different combinations for the issue of debentures.

1. Debentures issued at par, to be redeemed at par

2. Debentures issued at par, to be redeemed at premium

3. Debentures issued at par, to be redeemed at discount

4. Debentures issued at premium, to be redeemed at par

5. Debentures issued at premium, to be redeemed at premium

6. Debentures issued at premium, to be redeemed at discount

7. Debentures issued at discount, to be redeemed at par

8. Debentures issued at discount, to be redeemed at premium

9. Debentures issued at discount, to be redeemed at discount