Meaning and definition
The term “debenture”
indicates to the long loan or long-term debt. A company may raise its long-term
fund either by issuing of shares or by issuing of debenture. If a company
decide to raise capital, it issues shares, and if long-term loan then it issues
debenture. A debenture is a certificate issued by a company acknowledging
the debt of public borrowing. It is a portion of loan capital. The owners of
debentures are called debenture holders. They are the creditors of the company
and are entitled to receive an agreed and fixed rate of interest on their
debentures regularly. Generally, the debentures are redeemed at the end of their
maturity. The debenture holders have no right over the management and control
of the company.
Features of debentures
The following are the
main features of debentures:
o It is a written
certificate issued by the company as an acknowledgment of a debt
o It is issued under the
company’s seal
o It contains the rate
of interest to be paid to the subscribers
o It contains the mode
of payment of the principal amount and interest
o It is a long term
public borrowing from a large section of the general public
Types of debentures:
a) Registered
debentures:
A debenture that
cannot be transferred by a mere physical delivery is called a registered debenture.
The name of the holder of such debenture is registered with the company.
b) Bearer debenture:
A debenture, which is
transferable by mere delivery, is called bearer debenture. The holders of such
debentures are its owners and are called debenture holders.
c) Secured debenture :
A debenture, which is
issued against a specific fixed asset as security is called, secured debenture.
Upon default of such debenture on the due date, the debenture holder can
realize their sum out of the sale realized from such a fixed asset. Secured
debenture is also called a mortgaged debenture.
d) Unsecured
debenture:
Debentures issued
without any security are called unsecured debentures. The holders of such
debentures are not given any security for the issue of such debentures. The
holders of such debentures are treated as the general creditors of the company.
e) First debenture:
A debenture which is
issued against a specific fixed asset not currently pledge as a security for
the issue is called the first debenture. Such debenture needs to be repaid
fully before second debentures are issued.
f) Second debenture:
A debenture which is
issued against a specific fixed asset already used as security is known as the second
debenture. Such debentures are repaid only after the first debentures have been
fully settled.
g) Redeemable
debenture:
The debentures which
are to be repaid within a specified date as per the terms of their issue are
called redeemable debentures. The company is bound to pay the principal to
debenture holders after the expiry of the period specified at the time of the issue.
h) Convertible
debenture:
A debenture that is
issued with an option to convert it into a common share, preference share, or a
new debenture within a specified period at a conversion ratio is called a convertible
debenture.
i) Non-convertible
debenture:
The debentures, which
have no option of being converted into equity or preference shares or new
debentures, are called a non-convertible debenture.
j) Collateral
Debenture:
Debentures may also be
issued to money lenders, i.e to the banks and financial institutions as
additional security along with the principal security for the sanction of the
bulk amount of loan. Such debentures are called collateral debentures. The
moneylenders can exercise their rights as debenture holders if the issuing
company fails to pay the loan amount and principal security falls short to
recover the loan.
Difference between
shares and debentures:
|
Shares |
Debentures |
|
Shareholders
are the owners of the company |
Debenture
holders are the creditors of the company |
|
Dividend is paid on shares out of
profits on the recommendation of directors |
A fixed rate of interest is to be
paid to the debenture holders |
|
Rate
of dividend on the share capital is not fixed |
A
rate of interest is prefixed |
|
In the event of liquidation, the
shareholders fund is refunded after every claim is settled |
In the event of liquidation,
debenture holders are refunded before payment to shareholders. |
Importance of
debentures
o The importance of
debenture can be pointed out as follows:
o Debenture holders
receive a fixed rate of return on their investment.
o Debenture is refunded
before the refund of the share capital at the time of the winding-up of the
company.
o Debenture holder’s investments
are secured.
o Debentures are
transferable from one person to another.
Issue of debentures
A debenture is an
instrument issued under the common seal of a company, acknowledging its debt to
the holder under the terms and conditions specified. According to the company
act 2053, a public limited company can raise capital after the permission of
the concerned authority by issuing debentures with or without pledging
immovable assets of the company.
Issue of debentures
for cash
Debenture is issued
for cash consideration either at par or at a premium or at discount, just like
the issue of shares. The amount of debentures can be collected either on lump
sum (single instalment) or on instalment basis.
Issue of debentures on
a Lump-sum Basis:
If all the money is
collected in single instalment at the time of application then such issue of debentures
is said to be made on lump-sum basis. The whole amount of debenture is
collected in a single instalment with application form in this option.
Issue of debenture on
instalment basis:
The amount of
debenture may be collected in several instalments. The debenture money is
collected on several instalments as application, allotment and subsequent
calls as on shares. The entries regarding the issue of debentures are similar
to the entries of the issue of shares.
Issue of debenture at
par
If a company issues
debentures inviting the public to subscribe at face value(or nominal value)
then the debentures are said to be issued at par. Their par or face value is
printed on the face of debenture certificate.
Issue of debenture at
discount
A debenture may be
issued at a price less than its face value. Such as issue of debenture is
called issue of debentures at discount. For instance, when a company issues
debentures of Rs.1,000 face value per debenture at Rs.950 each, then Rs.50 each
is considered as a discount on the issue of debenture.
Issue of debenture at
premium
When debenture is
issued at a price higher than its face value, such as issue is known as issue
of debenture at premium. If the debentures face value of Rs.100 each is issued
t Rs.110, the excess of Rs.10 over the face value is termed as debenture
premium.
Calls in arrears
When debenture holders
fail to pay debenture allotment or/and debenture calls, such an outstanding
amount is called ‘calls in arrear’. There are two alternative methods of calls
in arrear they are;
Showing
calls-in-arrears: The outstanding amount on debenture allotment and
debenture calls is shown in a separate account called calls in arrears account.
Without showing calls-in-arrears: The calls in
arrears amounts are not shown separately in the book of account but are
deducted out of debenture allotment and/or debenture call.
Calls-in-advance
The company may
receive the debenture call amount in advance. Such an amount is known as
calls-in-advance. It may be received with allotment money for subsequent calls
or with first call money for the second and final call.
Oversubscription of
debentures
If the applications
received for debenture exceed the number of debentures offered to the public
then it is called the over-subscription of debentures. For example, if a
company issues 5,000 debentures of Rs. 100 each but receives applications for
8,000 debentures, then it is a case of over-subscription.
The company may deal
with the case of over-subscription with one of the following alternative
method:
i) Full rejection of
excess application method: Under this method, the excess applications for debentures
are rejected and the application money is returned along with a letter of regret
to those applicants whose applications were rejected.
ii) Pro-rata allotment
method: Under
this method, the debentures are allotted to all the applicants proportionately.
All the debentures applications are allotted on a pro-rata basis, i.e., in
proportion to what they have applied for. In other words, all the applicants
are offered less than the number of debentures applied for. Under this method,
the surplus money is adjusted against the allotment or subsequent calls.
iii) Mixed method: Under this method,
some applicants are fully accepted, some are accepted proportionately and some
are rejected. The application money should be refunded to whom no debentures
were allotted. The excess of application money on proportionately allotted
debentures may be utilized towards the allotment and subsequent calls.
Under-Subscription
Under-subscription is
a situation in which the total number of debentures issued is not fully
subscribed. It occurs when the number of debentures applied for is less than
the number of debentures offered. In this case, all the debenture applications
received are either accepted fully or rejected fully.
Issue of debentures
for Non-cash Considerations
The issue of
debentures for the considerations other than cash is called ‘issue of debenture
for non-cash considerations’. The company may issue debentures for discharging
the amount due on the purchase of assets, purchase of the business, and as
lateral securities.
Issue of debentures as
collateral security
The issue of
debentures to a bank/money lender for the sanction of a loan as collateral
security is called collateral debentures. On repayment of the loan, the collateral
security is automatically released but in case of failure of repayment, the
lender automatically becomes a debenture holder.
There are two
alternative methods for recording the debentures issued as collateral security.
First method: The issue of debentures
for collateral security is not recorded in the books of account but a note is
written in the balance sheet.
Balance sheet
As on……..
|
Liabilities |
Amount |
Assets |
Amount |
|
Loan ……………………….. (…Debentures of Rs…..issued as
collateral security for loan) |
XXXXX |
Bank ………………………. |
XXXXX |
|
|
XXXXX |
|
XXXXX |
Second method: Under this method, the
issue of debentures as collateral security is recorded in the books of account.
|
Date |
Particulars |
LF |
Debit Rs. |
Credit Rs. |
|
|
Debenture suspense a/c …………………………Dr.
To Debenture a/c (Being………………………………………..) |
|
XXXXX |
XXXXX |
Issue of Redeemable
Debentures
The debentures, which
are issued with a maturity date, are known as redeemable debentures. The
repayment of the principal amount of debentures to the debenture holders is
made on the maturity of the debentures.
Redemption of
debentures
Redeemable debentures
are issued with a maturity period. After the maturity of the period, the
principal amount of the debentures is repaid to the debenture holder. The
payment is made as per the terms laid down in the prospectus at the time of
issue of debentures. The methods of redemption of debentures are as follows:
Modes of Redemption of
Debentures
1.Redemption in installments
a) Redemption of a fixed
sum of debentures.
b) Redemption by the purchase
of debentures in the open market.
2.Redemption by conversion
3.Redemption in a lump
sum after the expiry of maturity period
a) Creating a sinking
fund or debenture redemption reserve account
b) Taking an insurance
policy.
Redemption of
debentures on lump-sum basis
Under this method, all
the principal amount of debentures is repaid at once on a lump sum basis. The
company may redeem the debentures after the maturity period is over or even
before the expiry of the specified period of time by serving a notice to the
debenture-holders.
Redemption of
Debentures by Annual Drawing/ Instalments
When the principal
amount of debentures is repaid by the annual drawing of debentures in equal
installments over the maturity period, such a process is called the redemption
of debentures by annual drawing. The company may redeem the principal annually
on equal installment.
Purchase of one’s own
debentures from open market
Under this method, the
company purchases its own debentures from the open market. The buying of
debentures is generally made prior to the expiry to the expiry of such
debentures; the buying of debentures is also called the redemption of the debenture.
Conversion of
debenture
Convertible debentures
are redeemed by converting them into new debentured or shares. Holders of
convertible debentures enjoy the option of having their debentures converted
either into shares or new debentures according to the terms and conditions of
the issue. The new debentures or shares can be issued either at par or at a premium
or at discount.
Writing off discount
on issue of debentures
Discount on the issue
of debentures is a capital loss. A separate account entitled loss on issue of
debentures account may also be opened to show discount on issue and provision
set aside for premium payable on redemption. The loss is written off as per the
decision of the BOD. The discount on the issue of debentures is shown on the
assets side of the balance sheet until it is fully written off.
The amount of discount
on the issue of debentures is written off in the following manner in case of redeemable
debentures.
1.
Annual installment basis:
The total principal amount of debentures may
be redeemed at the end of the maturity period in a single installment. Each
year an equal amount of discount is written off under this method. The amount
of annual discount to be written off is determined by using the following
formula.
2.
Debentures outstanding amount basis(Ratio)
When the debentures are redeemable by annual
drawings, the loss/discount on the issue of such redeemable debentures are
written off based on the debentures outstanding ratio.
Reviewed by Bijay Munikar
on
March 15, 2021
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