ISSUE OF DEBENTURES

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ISSUE OF DEBENTURES

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Issue of Debentures

Meaning of Debenture – A company can raise funds by issuing debentures. A debenture is an instrument of acknowledgement of a debt under the common seal of the company. In actual practice, debentures refer to long-term or perpetual indebtedness. According to Section 2 (12) of Indian Companies Act, debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge om the assets of the company or not.” Terms of repayment of the principal sum and payment of interest are given in each debenture certificate. It is usual to prefix “Debentures” with the rate of interest. Thus, if the rate of interest is 12%, the name given will be “12% Debentures.”

Kinds of Debentures

Debentures are classified from various point of views as follows:

(1) From security point of view – From this point of view, debentures may be put into two categories – naked debentures and mortgage debentures. Naked debentures are those which provide no security to the lenders for the payment of interest and repayment of principal. Such debentures are not very common. Mortgage debentures, on the other hand, are those which are secured. The security may be a particular asset called fixed charge or it may be the assets in general called floating charge.

(2) From permanence point of view – From this point of view, debentures may be either redeemable or irredeemable. Redeemable debentures are those which are repayable after a specified time or by instalments during the existence of the company while irredeemable debentures are those which are not repayable during the lifetime of the company issuing it and hence they are repaid only when the company goes into liquidation. Usually, debentures are redeemable and their terms of redemption are given in the debenture certificate.

(3) From record point of view — From this point of view, debentures can be bearer or registered. Bearer debentures are those which are transferable by mere delivery. Such debentures are repayable to their bearers. Company does not keep any record of debentureholders. Interest on such debentures is paid to those persons who produce to the company coupons attached with the debentures. On the other hand, registered debentures are those, the names of whose holders are registered in the books of the company, These debentures can be transferred only by the execution of a regular transfer deed. Interest on such a debenture is paid to the person whose name appears in the company’s register.

(4) From the priority point of view — From this point of view, debentures may be first debentures. second debentures and so on. First debentures are those which are repayable before other debentures while second debentures are those which are repaid only when first debentures have been redeemed.

(5) From the convertibility point of view — From this point of view, debentures can be either convertible or inconvertible. Convertible debentures are those the holders of which are given an option of exchanging the whole or a part of the amount of their debentures for shares on certain dates or during certain periods as laid down in the terms of issue. Thus, debentures can be fully convertible (FCD) or partly convertible (PCD). Fully convertible debentures are whose full amount is converted into equity shares of the company on the expiry of a specified period. Partly convertible debentures consist of two parts — convertible and non-convertible. Convertible portion of such debentures is converted into equity shares at the expiry of specified period whereas non-convertible portion is redeemed at the expiry of a certain period. Non-convertible debentures are those which are not convertible into shares and the whole amount of which is redeemed in accordance with the terms of issue.

Issue of Debentures

A company can borrow by issuing debentures subject to the restrictions imposed by section 293 (1) (d) of the Companies Act. The procedure for issuing debentures is very much similar to that of an issue of shares. A prospectus is issued in which terms and conditions of the issue are given. The intending lenders apply for debentures in the company on a prescribed form, which is deposited with the company’s bankers alongwith the application money. The company may ask for payment of the whole of the amount along with the application or by instalments. If debentures are issued payable by application, allotment and call instalments, the same procedure will be followed as for shares. That is to say, Debenture Application and Allotment Book, Debenture Call Book, and a Register of debenture-holders will be employed for recording the details of the debentures issued.

Like shares, debentures may also be issued either (i) at par, or (ii) at a premium, or (iii) at a discount but restrictions of Sections 78 and 79 do not apply in the case of debentures.

Accounting Entries – Debentures may be issued by a company (1) for cash. (2) for consideration other than cash and (3) as collateral security. Accounting entries under each circumstance are given hereunder.

(1) Debentures Issued for Cash

(A) Issue of debentures at par

A debenture is said to have been issued at par when the amount collected for it is equal to the face value of the debenture. Accounting entries, in this case, are as follows:

(B) Issue of Debentures at Premium

Debenture is said to have been issued at premium where an applicant is required to pay a total sum in excess of the face value of the debenture, the premium being the difference of issue price and face value of the debenture. Prior to Companies (Amendment) Act, 1999, there was no mention of debenture premium any where in the Act. Hence, the amount of debenture premium could be used for any purpose for which the profits of the company can be used including even for distribution of dividend. However, companies following the principle of conservatism were usually transferring such premium to Capital Reserve Account at the end of the year and the same could be utilised in writing off capital losses like discount on issue of shares and debentures, premium on redemption of shares and debentures, underwriting commission, preliminary expenses etc. and also goodwill.

The Companies (Amendment) Act, 1999 substituted the words Share Premium Account by the words Securities Premium Account’. Section 2 (45AA) inserted by the Companies (Amendment) Act, 2000 defines securities to include inter alia debentures and debenture stock also. Thus, now the words Securities Premium Account would also cover the premium on issue of debentures also. Hence, now the amount of premium on issue of debentures would be credited to Securities Premium Account.

Illustration 2. TELCO Ltd. issued 20,000 12% Debentures of Rs. 500 each at Rs. 550 payable Rs. 125 on application, Rs. 175 (including premium) on allotment and the balance on final call. The issue was fully subscribed and the moneys were duly received.

Show the necessary Cash Book and the Journal entries and prepare the Balance Sheet of the company.

Issue Debentures Study Material

Debenture is said to have been issued at discount where an applicant is required to pay a total sum less than the face value of the debenture. The excess of the face value over the issue price is regarded as the discount. When debentures are issued at a discount, cash account is debited with net sum received, the Discount on Debentures account is debited with the amount of discount allowed and the Debentures Account is credited with the full nominal value of the debentures. But if, the amount of debenture is payable in installments, the entry for discount is made with the allotment as follows:

Debenture Allotment account Dr. (with the money due on allotment)

Discount on Issue of Debentures account Dr. (with the amount of discount)

To Debentures account (with the total)

There is no legal restriction on the companies for issuing debentures at discount. Maximum limit for discount on debentures is also not prescribed by the Companies Act. However, this Act requires that the amount of discount must be shown on the assets side of the Balance Sheet till written off under the head “Miscellaneous Expenditure.”

Illustration 3. X Ltd. issued 10,000 13% Debentures of Rs. 100 each at Rs. 95, payable Rs. 20 on application, Rs. 25 on allotment and the balance on call. All the debentures were applied for and allotted and the moneys were duly received. Show Journal entries and prepare Balance Sheet.

Write off of Discount on Issue of Debentures

Discount on issue of Debentures is a capital loss of the company. Although there is no legal obligation E me company to write off such a loss, sound accounting policy requires that it should be written not at the earliest. There are two ways of writing off this loss :

(1) Being a loss of capital nature, it can be written off against capital profits and/or share premium account of the company.

(2) It can be treated as deferred revenue expenditure and can be written off against revenue profits over the period having the benefit of the use of the money raised by debentures. There can be the following two methods to achieve this end :

(1) Equal Installment Method – Under this method, the total discount is spread over the life of the debentures equally. So, the amount of discount to be written off annually is calculated by dividing the total amount of discount by the number of years after which the debentures will be redeemed. This method is suitable only if the debentures are repayable at the expiry of a given period.

(2) Fluctuating Installment Method or Proportion Method – Where the debentures are repayable by annual drawings, the first method becomes unsuitable because in such a case, the burden of discount will not be in proportion of the benefit received by the company out of the money raised by issuing debentures. Under the second method, the total discount is written off during the life time of debentures in proportion to the debentures outstanding at the beginning of each year. So, the amount of discount written off each year will go on diminishing every year under this method.

Illustration 4. On 1st January 1990, Voltas Ltd. issued 5,000, 10% Redeemable Debentures of Rs. 100 each at a discount of 6%. The debentures were repayable by annual drawings of Rs. 1,00,000 over the period of five years. Determine the amount of discount to be written off each year and prepare Discount on Issue of Debentures Account for five years in the books of the company.

Calls-in-Advance and Calls-in-Arrear on Debentures

If the amount of debentures is payable in installments, alike shares there can be calls-in-arrear and callsin-advance on debentures too. If a debenture holder pays the amount before calls are made, the amount of advance will be credited to “Calls-in-Advance on Debentures Account” just as in case of shares. If the company accepts such advance, subject to the provisions of Articles, it can pay interest on such money from the date of the receipt till the due date of the call. Such interest is debited to P. & L. account.

If a debenture holder has failed to pay any call/calls made on him, the company can forfeit his debentures for non-payment of any call but it can not sue against the defaulter under section 122 for the recovery of the arrears. Accounting entries for calls-in-arrear on debentures are just similar to those passed in case of shares.

Illustration 7. A company issued for subscription 1,000 15% Debentures of Rs. 100 each at the rate of Rs. 105 each payable Rs. 20 on application, Rs. 35 (including the premium) on allotment and the balance in two equal calls. Applications for the debentures were received and the allotment was made. One debenture holder holding 200 debentures paid all the money with allotment. As per provisions in the Articles, the company paid Rs. 150 as interest on this advance money.

Give Journal entries in the books of the company.

Debentures Issued as Collateral Security

The term ‘collateral security’ implies subsidiary or secondary security given for a loan. When debentures are issued as a subsidiary or additional security for a loan from a bank or insurance company, such an issue of debentures is known as ‘issue of debentures as collateral security.’ No interest is payable on such debentures, the interest on the loan being paid in the usual way. Such debentures remain in the possession of the lender until and unless the loan is repaid. On repayment of the loan, the lender is bound to return the debentures. But in case loan is not repaid by the company on the due date, the lender will become a debentureholder entitled to exercise all the rights conferred by the debentures including the right to sell the debentures in the market.

Issue of debentures in such a case can be dealt with in either of the following two ways:

(a) First Method – At the time of issue of such debentures, no entry is passed in the books of the company but a note is appended below the item of loan in the liabilities side of the Balance Sheet mentioning the fact that it has been secured by the issue of debentures as collateral security.

Second Method – If it is desired to record this event in the books of account, following entries will be passed :

(1) On issue of debentures as collateral security –

Debenture Suspense Account Dr. with the face value of debentures

To Debentures Account issued

Debenture Suspense Account is shown in the assets side of Balance Sheet under the head Miscellaneous Expenditure’ while Debentures Account is shown in the liabilities side under the head “Secured Loans’.

(ii) On repayment of the loan and release of debentures, the above entry is cancelled by passing a reverse entry. As the net effect of (i) and (ii) is nil, this method is rarely followed in practice.

Illustration 11. Bharat Ltd. issued Rs. 8,00,000 12% Debentures, of which Rs. 2,50,000 were issued for cash at par, another Rs. 2,50,000 at a premium of 5% and the remaining Rs. 3,00,000 were given to the bank as security of a loan of Rs. 2,00,000. Journalise these transactions in the books of the company and show how these transactions will appear in the Company’s Balance Sheet.

Issue of Debentures redeemable at premium

If a company issues debentures redeemable at a premium, such premium on redemption is a capital loss to the company and hence should be dealt with in the same way as discount on issue of debentures. As premium on redemption is a known loss, it would be prudent on the part of the company to spread this loss equitably over the life of the debentures. For this purpose, the liability for premium payable on redemption is recorded in the books at the time of issue of the debentures by passing the following accounting entry :

Bank Account Dr.(With the amount received on issue of debentures)

Loss on Issue of Debentures Account Dr. (With the amount of loss to be incurred)

To Debentures Account (With the nominal value of debentures issued)

To Premium on Redemption of Debentures A/c (With the amount of premium payable on redemption)

When the debentures are issued at a discount and are redeemable at a premium, the loss on issue of debentures will be equal to the total of the amount of discount on issue and the amount of premium on redemption. In such a case, there is no need to debit Discount on Debentures Account for the amount of discount allowed. Instead, it is included in “Loss on Issue of Debentures Account”.

The “Loss on Issue of Debentures Account” is written off gradually every year during the lifetime of the debentures so that it is completely written off before the debentures are due for payment. The unwritten off portion of this account appears in the Balance Sheet on the assets side under the head “Miscellaneous Expenditure”. “Premium on Redemption of Debentures Account” appears in the Balance Sheet on the liabilities side until it is paid on redemption of debentures.

Illustration 13. Journalise the following transactions at the time of issue of debentures :

(1) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at par which are redeemable at par. (2) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at par which are redeemable at 6% premium.

(3) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at par which are redeemable at 6% discount.

(4) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at 10% premium which are redeemable at

(5) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at 10% premium which are redeemable at 6% premium.

(6) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at 10% premium which are redeemable at 6% discount

(7) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at 6% discount which are redeemable at par.

(8) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at 6% discount which are redeemable at 6% premium.

(9 ) A Ltd. issued 10,000 12% Debentures of Rs. 100 each at 6% discount which are redeemable at 6% discount.

Interest on Debentures

Wherever a company issues debenture it undertakes to pay periodically interest thereon at a fixed percentage. Interest payable on debentures is a charge against the profits of the company, i.e., it is to be paid by the issuing company to the debenture holders irrespective of the fact whether the company earns profit or not. If interest is payable only if the company earns profit then such debentures are termed as ‘income bonds’. Interest on debentures is normally payable half-yearly and is calculated at the fixed percentage on the nominal value of the debentures issued and not on the issue price.

According to the Income Tax Act 1961, a company is liable to deduct at source and deposit it with the government to the credit of the debenture holders, income tax at the prescribed rate from the gross amount of interest payable on debentures before the actual payment is made to the debenture holders. The accounting entries in such a case are as follows:

(1) On interest becoming due : Debenture Interest Account Dr. (with the gross amount of interest due)

To Income Tax Payable Account (with the amount of income tax deducted)

To Debenture holders Account (with the net amount payable)

(2) On payment of interest : Debenture holders Account Dr. with the amount To Bank Account of interest paid

(3) On depositing the tax to the Government : Income Tax Payable Account Dr. with the amount To Bank Account of tax deposited

(4) The gross amount debited to Debenture Interest Account is transferred to the Profit and LOSS Account at the end of the year. The entry is : Profit and Loss Account Dr. To Debenture Interest Account Notes:

(i) If the examination problem is silent as to the tax deducted at source, students need not make entries for income-tax payable on debenture interest. A footnote may be given in this regard.

(ii) If the company fails to deposit with the Government the tax deducted at source, it will be treated as the liability and shown as a current liability in the Balance Sheet.

(iii) If the debentures are tax free, the interest payable on debentures has to be grossed up. In such a case, tax is paid on interest by the company on behalf of the debenture holders.

Illustration 15. Zed Ltd, had issued Rs. 20,00,000 14% debentures on which interest was payable half yearly on 30th September and 31st March. Show the necessary journal entries relating to debenture interest for the year ended 31st March 1998 assuming that all money were duly paid by the company. Tax deducted at source is 10%

Discussion Questions

Long Answer Questions

1 What are debentures? What are their various classes ?

2. Distinguish between share and debenture. Describe the different kinds of debentures

3. Explain the meaning of debentures issued as collateral security by a company. Show its treatment in the Balance Sheet.

4. What is debenture discount? How can it be written off?

5. What do you understand by issuance of debentures at par, discount and premium ? Pass the necessary journal entries under all the three cases by taking imaginary examples.

6. Explain with examples the methods of writing off discount on issue of debentures.

7. A company issues debentures, which are redeemable at a premium. Will it make any difference for accounting purposes if these debentures were issued at a premium or at a discount or at par ? Explainfully.

8. Give the journal entries in the following conditions:

(a) Debentures – Issued at par and redeemable at par.

(b) Debentures – Issued at par and redeemable at discount.

(d) Debentures – Issued at discount and redeemable at par.

(e) Debentures – Issued at discount and redeemable at discount.

(1) Debentures Issued at discount and redeemable at premium.

(g) Debentures – Issued at premium and redeemable at par.

(h) Debentures – Issued at premium and redeemable at discount.

(1) Debentures – Issued at premium and redeemable at premium.

Short Answer Questions (Weightage 2 to 5 marks)

(i) Give different kinds of debentures

(ii) Explain the main differences between debentures and shares.

(iii) How does discount on issue of debentures written off?

(iv) How does issue of debentures as collateral security accounted for in the books of the company ?

(v) Give journal entry for accounting the issue of debentures at discount and redeemable at premium.

(vi) Give journal entry for accounting the issue of debentures at discount and redeemable at discount.

(vii) How will you deal with the discount on issue of debentures when the debentures are :

(a) to be redeemed in lump sum at the expiry of specified period ?

(b) to be redeemed in instalments ?

(viii) State how will you deal with the loss on issue of debentures in the books of accounts.

Numericals

(i) X Ltd. issued 2,500, 7% debentures of Rs. 100 each payable as 10% on application, 20% on allotment, 30% on Ist call and balance on 2nd and final call. Ist call and 2nd and final call amounts were not paid on 500 debentures. Pass the necessary journal entries in the books of X Ltd. (Garhwal 2005 R)

(ii) X Ltd. took a loan of Rs. 20,000 from a bank and deposited 300, 8% debentures of Rs. 100 each with the bank as collateral security. Journalise the transaction in the books of the company and show how this will appear in the company’s balance sheet.

(iii) Pass necessary journal entries in the following:

(a) 1,000,8% debentures of Rs. 100 each are issued at par and are redeemable at 4% premium.

(b) 1,000, 10% debentures of Rs. 100 each are issued at 5% discount and are redeemable at 2.5% premium

(iv) (a) ABC Ltd. issued 5,000, 10% redeemable debentures of Rs. 100 each at a discount of 5% redeemable after 5 years at a premium of 2%. Show the journal entries for the issue of debentures.

(Answer : Loss on issue of debentures Rs. 35,000)

(b) Vandana Ltd, issued to bank for a loan of Rs. 7,00,000 as collateral security, 10,000 debentures of Rs. 100 each. Journalise the transaction.

(Answer : Debenture suspense Rs. 10,00,000)

(V) R Ltd. issued 9,000, 12% debentures of Rs. 100 each at a discount of 6% to be redeemed as follows:

Objective Type Questions (A) State whether the following statements are True or False :

(i) A company can start its business by issuing debentures only.

(ii) Debentures can be issued by a partnership firm also.

(iii) Debenture interest is payable only when a company makes profit

(iv) A company can not buy its own debentures.

(V) It is compulsory that discount on issue of debentures must be written off before the redemption of debentures.

(vi) Loss on issue of debentures is a capital loss.

(vii) Maximum rate of debenture discount is 10%.

(viii) A company is bound to write off ‘discount on issue of debentures to profit and loss account.

(ix) Debentures which are redeemed after a certain period are called redeemable debentures.

(x) If debentures of Rs. 3,00,000 are issued at par but redeemable at 5% premium then Loss on Issue of Debentures Alc will not be opened.

(Answer: True : (vi), (ix); False : (i), (ii), (iii), (iv). (v). (vii), (viii), (x))

(B) Fill in the blanks :

(i) Debentures which can be transferred by mere delivery are called ………. debentures.

(ii) A company can not issue ……….. debentures.

(iii) Debentureholders are entitled to receive ………… at fixed rate.

(iv) Premium on issue of debentures account is a ……….. account.

(v) Discount on issue of debentures is a ………… loss.

(Answer: (i) bearer (ii) irredeemable (iii) interest (iv) personal (v) capital)

(i) Debenture holders are :

(a) .creditors

(b) owners

(d) none of these

(ii) Premium on issue of debentures is in the nature of:

(a) Personal Account

(b) Real Account

(Agra 2004)

(iii) Premium on redemption of debentures is in the nature of:

(a) Personal Account

(b) Real Account

(iv) The following journal entry appears in the books of A Ltd. :

Bank Account Dr. 1,92.000

Loss on Issue of Debentures Account 20,000

To 10% Debentures 2,00.000

To Premium on Redemption of Debentures Account 12.000

Debentures have been issued at a discount of:

(a) 10%

(b) 4%

(d) 8%

(V) The journal entry for debenture issued at par and are redeemable at par:

(a) Bank Account Dr (b) Debentures Account Dr.

To Debentures Account To Bank Account

To Bank Account

(vi) If debentures of the nominal value of Rs. 1,00,000 are issued at a discount of Rs. 10 for net assets with Rs. 80,000, the balance of Rs. 10,000 will be debited to:

(a) Goodwill A/C

(b) Capital Reserve Alc (c) P. & L. A/c.

(Answer: (i) a, (ii) a, (iii), (iv) b, (v) a, (vi) a)

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DR. PRAVEEN KUMAR-9760480884

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ISSUE OF DEBENTURES

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