DEBENTURES: DEFINITION, MEANING, TYPES, AND FEATURES ACCOUNTANCY CLASS 12
Governments and companies use debentures to make loans. The loan is at a fixed interest rate according to the reputation of the companies. When companies need to borrow some money to develop themselves, they take the help of debentures. Let’s understand the meaning of the term ‘Debentures’.
DEBENTURES MEANING & DEBENTURE DEFINITION:
A debenture is a document issued by a company under its seal to the subscribers to the debenture capital of the company. It is a document that acknowledges a debt owed to the subscriber/s by the company. The Indian Companies Act, 2013 not only defines a debenture but also provides for its issue conditions and procedures. In the USA debentures are called as Bonds.
Debentures are securities (documents) issued by the company like share certificates issued by the company, having a face value. But it is important to understand that while share certificate is issued to the subscribers of share capital which equity of the company while debentures certificates are issued by the company to the subscribers to debt capital of the company. Share capital being equity is not returned, while debenture capital being debt is returned or returnable by the company. While shareholders get returns called dividend with no limits on the rate but given at the discretion of the company management, the debenture holders get a fixed rate of return in the form of interest. It is compulsory on the company to pay interest whether there is profit or loss; in fact, interest paid is a charge on profit meaning it is a business expense, while dividend being a distribution of the profits not a charge on a profit of the company as it is paid only out of profits (not an expense).
Now it is important to understand the types of debentures a company may issue.
TYPES OF DEBENTURES
The debenture classification depends on their redemption, maturity, convertibility, security, redemption method, interest rate, coupon rate and performance.
- Secured and Unsecured Debentures:
Secured Debentures are debentures that are secured against the assets of the company. And if there is any default on repayment of such debentures, then such asset is charged.
While Unsecured Debentures do not guarantee any charges neither against the assets of the company nor are they fixed or floating. Usually these debentures are not issued by companies in India.
- Convertible and Non-Convertible Debentures:
Convertible Debentures can be converted into equity shares at the option of the debenture holder, after a certain time interval he may convert all his shares into equity shares and he becomes a shareholder.
Non-Convertible Debentures are the most common types of debentures which do not have an option to convert into shares or equity of any kind. These debentures will last until their maturity.
- Redeemable or Irredeemable Debentures:
Redeemable Debentures are issued at the end of its term. This means that at the end of a certain period, they will be paid either in installment in one or the other or in a lump sum. Such debentures can be redeemed at a premium or discount.
Irredeemable Debentures are the permanent ones. There is no fixed date to pay them. They can be rescued as the company goes into liquidation process. Or they can be retrieved after unspecified long intervals.
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FEATURES OF DEBENTURES
- A debenture acknowledges a debt that usually shows the amount & date of repayment of the loan.
- Interest payable on a debenture is a charge against profit and hence it is a tax deductible expenditure.
- Interest on debenture is payable even if there is a loss.
- A Debenture-holder may either repay the debt or even convert the debenture into shares or other debentures.
- Debentures are the evidence of debt that shows that the company owes a debt to the debenture-holder.
- They may or may not carry a charge on the company’s assets.
- Debentures are generally transferable; a Debenture-holder can sell them on stock exchanges at any price.
- Debenture holders do not enjoy any voting right.
ISSUE OF DEBENTURES
There are two things that we need to keep in mind while treating debentures in accounting
– Issue of debentures
– Terms of issue of debentures
There are three methods for issuing debentures
– Issue of debenture for cash
– Issue of debenture for consideration other than cash
– Issue of debentures as collateral security
A company can issue debentures with multiple classifications; like it can issue convertible redeemable debentures. There are certain restrictions placed by the Government. When debentures are issued with some assets of the company as security against non-payment of principal debt and/or interest, they have secured debentures, otherwise, it is unsecured debentures. If the debentures can be converted into share certificate at the choice of the debenture-holder after fixed time from the issue of the debentures, they are convertible-debentures. Redeemable means that can be redeemed or returned. So, debentures that can be repaid or returned after a fixed time (mentioned on the debentures) of the issue of debentures, are called redeemable debentures. But it is important to remember that if a debenture is irredeemable the debenture loan need not be repaid. Irredeemable means it can be repaid at any time at the discretion of the company. Debentures issued as collateral security is not a debenture issued in a real sense. When a company takes a loan to say from a bank or any other financial institution, it may give in writing as a security for the repayment of the loan, as agreed, that on non-repayment at maturity equivalent amount of debentures will be issued in the names of the lender/s. So, it means non-accounting entry at the time of giving debentures as collateral security to the Bank, but if the loan is not repaid and the debentures are issued in the name of the bank then accounting entry for the actual issue shall be required to be made.
Having described the types of debentures, let me briefly explain that since debentures are loan, the terms of redemption are decided at the time of issue itself. Like shares, debentures can be issued at par, discount, and at a premium. Discount is a loss while the premium is a profit to the company issuing debentures. At the time of redemption also it can be at par, discount, or premium. But remember discount at the redemption is a gain/profit to the company and premium is a loss to the company. The accounting concept of conservatism says the loss at the time of redemption must be accounted at the time of issue along with loss/profits on the issue of debentures. So premium at the time of redemption, a loss, must be accounted in the books at the time of issue of debentures. But discount at the time of redemption, being a profit, will not be accounted for in the books of accounts.
Change in Profit Sharing Ratio
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