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Issue and Redemption of Debentures

Meaning of debentures, difference between shares and debentures, types of debentures

Objective

After going through this lesson, you shall be able to understand the following concepts.

  • Meaning of Debenture and its Features
  • Difference between Shares and Debentures
  • Types of Debenture

Introduction to Debentures

In the previous chapter, we learnt about shares and also understood how a company issues shares to the general public in order to raise capital. Similar to the shares, debentures are also issued by a company to meet its capital requirements. The word debenture is derived from a Latin word 'debere' which means to borrow. A debenture is a debt instrument issued in the form of a certificate under the seal of a company and containing a contract for the repayment of the principal sum after a fixed period of time and payment of interest at regular intervals, generally half yearly. Debentures are issued by a company for meeting its capital needs and considered as long-term borrowings of the company.

According to Section 2(30) of the Companies Act, 2013, 'Debenture' includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

In other words, debentures are instruments to raise long-term debt, issued by a borrower company for acknowledging debt. It is an instrument in writing that specifies the rate and time interval for payment of interest and terms and condition for repayment of principle amount of the debt.

Similar to the shares, debentures can be issued by a company either to raise its capital or to purchase assets and business. The holders of debentures are known as debentureholders. Debentures are generally freely transferable from one debentureholder to another debentureholder. 

Features of Debenture

The mentioned below are some features of debenture.

  1. It is a debt instrument issued by a company.
  2. It is issued under a seal of a company.
  3. It specifies the way of repayment of principal sum and interest on specific intervals and also specifies the date of its redemption.
  4. It is a transferable instrument and thus can also be considered as a movable property of the company.
  5. It is a long-term borrowings of the company.

Difference between Shares and Debentures

Shares and debentures are the two sources for raising capital by a company. The main points of differences between the two are given below.

Basis of Difference

Shares

Debentures

1. Owner or Creditor

Share holders are the owners since shares forms a are part of owned capital

Debenture holder are Creditors since debentures are a part of loan

2. Voting Rights

Share holders have the voting rights

Debenture holders do not have any voting rights.

3. Returns

Share holders are entitled for returns in  the form of dividend.

Debenture holders are entitled for returns in the form of interest.

4. Rate of Return

The rate of dividend is not fixed and varies from year to year.

The rate of interest is fixed and do not vary from year to year.

5. Obligations of Return

Dividend is appropriation of profit. Dividend will not be paid if losses are incurred by the company

Interest is charged against profit, interest is payable even if there is no profit.

 

6. Repayment of Amount

The amount of share is not returned during the life time of the company

The amount of debenture is returned according to the term of issue.

7. Issue

As per the Section 53 of Companies Act 2013, shares cannot be issued at discount, except sweat equity shares (as mentioned in Section 54 of 2013 act). On the contrary, the earlier enforced act i.e. Companies Act of 1956, allowed the issue of shares at discount as per the conditions laid by Section 79 of the act.

There are no such restrictions for issuing debentures on discount.

8. Conversion

Shares cannot be converted into debentures.

Debentures can be converted into shares.

9. Risk

Shares are more risky than debenture as these are unsecured.

If debentures are secured against asset, the risk involved is the minimal.

10. Repayment Priority

Payment to the share holders is made after settlement of all external liabilities, i.e. after debenture holders.

Payment to the debenture holders is made before the share holders.


Types of Debentures

There are different types of debentures. Debentures can be classified on the following basis.

  1. On the Basis of Security
  2. On the Basis of Tenure
  3. On the Basis of Mode of Redemption
  4. On the Basis of Coupon Rate
  5. On the Basis of Registration

On the Basis of Security- On this basis, debentures can be classified as Secured Debentures and Unsecured Debentures.

    1. Secured Debentures- These debentures are those debentures that are secured against some asset/s of a company. These are also known as Mortgaged Debentures. In case the company fails to pay back the principal amount of debentures or fails to meet its interest obligations on the due date, then the holders of such debentures have a right to sell the mortgaged asset in order to realise their amount due to the company.
    2. Unsecured Debentures- These debentures are those debentures that are not secured against the asset/s of a company. In short, these debentures do not have any security with respect to its principal amount along with interest amount. The holders of such debentures are are treated as unsecured creditors.
  1. On the Basis of Tenure- On this basis, debentures can be classified as Redeemable Debentures and Irredeemable Debentures.
    1. Redeemable Debentures- These debentures are those debentures which are issued for a specific period of time. Such debentures are payable (or redeemable) after the expiry of that specific period. These debentures can be redeemed at par or premium either in lump-sum or in instalment.
    2. Irredeemable Debentures- These debentures are those debentures that cannot be redeemed by a company during its life time. There are repayable only at the time of winding up of a company. These are also known as Perpetual Debentures that means debentures having indefinite life. In India, now days, no company can issue irredeemable debentures.
  1. On the Basis of Mode of Redemption- On this basis, debentures can be classified as Convertible Debentures and Non-Convertible Debentures.
    1. Convertible Debentures- These debentures are those debentures that can be converted into equity shares or other securities after a specified period of time. Convertible Debentures can be further divided into Fully Convertible Debentures and Partly Convertible Debentures.
      1. Fully Convertible Debentures- When the whole amount of a debenture is convertible into equity shares or other securities of equivalent amount, then these debentures are called Fully Convertible Debentures. There is no need to maintain Debenture Redemption Reserves for such debentures.
      2. Partly Convertible Debentures- When only a part of amount of a debenture is convertible into equity shares or other securities, then these debentures are called Partly Convertible Debentures. In this regard, the Debenture Redemption Reserve is maintained only for the non-convertible part of the debentures.
    2. Non-Convertible Debentures- Non - Convertible Debentures are those debentures which cannot be converted into shares. Generally debentures are non - convertible.
  1. On the Basis of Coupon Rate- On this basis, debentures can be classified as Zero Coupon Rate Debentures and Specific Rate Debentures.
    1. Zero Coupon Rate Debentures- These debentures do not contain a specific rate of interest and can be issued at discount. In other words, interest rates these debentures are not specified. The excess of the face value of the debenture over its issue price is considered as interest amount.
    2. Specific Rate Debentures- These are the debentures that are issued with a specific rate of interest which may be either fixed or floating.
  1. On the Basis of Registration- On this basis, debenture can be classified as Registered Debentures and Bearer debentures.
    1. Registered Debentures- These are those debentures, on the issue of which the company has to maintain a record regarding name, address and number of holding of debentures in the Register of Debentureholders of the company. Such debentures are not easily and freely transferable.
    2. Bearer Debentures- When a company does not maintain any record of the debentureholders and the debenture is transferable mere by delivery, then the type of debenture held by the holders is termed as Bearer Debenture. Interests on such debentures are paid to the persons who produce the interest coupons that are attached with these debentures in a specified bank.

Exercise

Complete each of the following sentences by choosing the appropriate word in the space provided.

1. Debentures is ________ instrument issued under a common seal of the company. (a debt/an equity)

2. Company pays _________ on debentures at regular interval. (dividend/interest/commission)

3. ________ holders have right to vote in the General Meeting of the Company. (Share/Debenture)

4. At the time of winding up of a company accepts claim of _________ prior to _________. (Preference Shares/Debentures)

5. Debentures have _________ (Debit/Credit) balance. It is _________  (an expense/ an asset/a liability) to the company.

Solutions

1. a Debt

2. Interest

3. Shareholders

4. Debentures, Preference Shares

5. Credit Balance, a Liability.

Objective

After going through this lesson, you shall be able to understand the following concepts related to the issue of debentures for cash.

  • Issue of Debentures at Par, Premium and Discount
  • Issue of Debentures- Lump-sum Issue and Instalment Issue
Issue of Debentures

A company issues debentures in the same way as it issues shares to the general public for meeting its capital requirement. Also, the accounting treatment for the issue of debentures is similar to that for the issue of shares. A company is required to prepare a prospectus which will be offered to the public for inviting them for subscribing debentures. This prospectus contains all the terms and conditions relating to the issue and redemption of the debentures. Debentures can be issued at par, at premium or at discount. That is, unlike shares, there is no such restriction on the issue of debentures at discount. Debentures can be issued in the following forms.
  1. Issue of Debentures for Cash
  2. Issue of Debentures for Consideration other than Cash
  3. Issue of Debentures as Collateral Security

In this chapter we will study the Issue of Debentures for Cash. A company can issue debentures at their face value or at a value that is less than or more than their face value. Accordingly, the issue of debentures for cash can be classified as:  

  1. Issue of Debentures at Par (Issue Price = Face Value)
  2. Issue of Debentures at Premium (Issue Price > Face Value)
  3. Issue of Debentures at Discount (Issue Price < Face Value)

Issue of Debentures 'At Par'- When a company issue debentures at a price equal to the nominal or face value of the debenture, then it is known as Issue of Debentures at Par. For example, a debenture having a face value of Rs 15 is issued at the same value i.e. Rs 15. In this case, the issue price of debenture is equal to its face value. Therefore, it is a case of issue of debenture at par. 

Issue of Debenture at 'Premium'- When the debentures are issued at a price more than the face value (or nominal value) of debenture, it is known as Issue of Debentures at Premium. In this case, issue price is more than the face value of debenture. The difference between the issue price and face value is considered as premium. This premium is credited to the Securities Premium Account. For example, a debenture of a face value of Rs 50 is issued at Rs 65. The excess of issue price (Rs 65) over its face value (Rs 50) i.e. Rs 15 (Rs 65 – Rs 15 ) is a amount of premium. The amount of Securities Premium can be utilised for the purposes as stated in section 52 of the Companies Act, 2013 (Section 77A and 78 of the Companies Act, 1956)

Issue of Debentures at 'Discount'- When a company issues debentures at a price less than its face value, then it is known as Issue of Debentures at Discount. For example, a debenture of face value of Rs 100 is issued at Rs 90. In this case, the issue price (i.e Rs 90) is lesser than the face value (i.e. Rs 100). Therefore, it is a case, where debentures are issued at a discount of Rs 10. The difference between the issue price and face value of debenture is considered as Discount. In this example, the amount of discount allowed on debentures (i.e. Rs 10) is regarded as a loss to the company. Unlike shares, there is no specific restrictions on issue of debentures at discount by the Companies Act. However, the Article of Association should contain the provision for issue of debentures at discount.

Issue of Debentures for Cash

Whenever a company attempts to raise capital in cash by issuing debentures to the general public, then this process is known as issue of debentures for cash. Similar to the cases of shares, a company can call the entire debenture money in just one single instalment or in number of instalments. Thus, depending on the number of instalments, the issue of debentures can be segmented in two cases namely- Lump-sum Issue and Instalment Issue. This is explained diagrammatically below.  


 

Lump-sum Issue (when whole Debenture amount is payable on application)

If a company calls for the entire debenture money in one single instalment, then such issue of debentures is known as issue of debentures for cash in lump-sum. In this case, the debentureholders have to pay the whole debenture money in just one instalment that is at the time of application.

At the time of Application

Bank A/c                   (No. of debentures × Issue Price of debentures)

Dr.

To Debentures Application A/c (No. of debentures × Issue Price of debentures)

(Amount received on application)

At the time of lump-sum issue at par

Debenture Application A/c 

Dr.

To __ % Debentures A/c (No. of debentures × Face Value of debentures)

(Application money transferred to debenture account on allotment)
At the time of lump-sum issue at premium
Debenture Application A/c                                                                                Dr.
                   To __ % Debentures A/c (No. of debentures × Face Value of debentures)
                   To Securities Premium A/c

(Application money transferred to debenture account on allotment)

At the time of lump-sum issue at discount
Debenture Application A/c                                                                                Dr.
Discount on Issue of Debentures A/c                                                                Dr.
                  To __ % Debentures A/c (No. of debentures × Face Value of debentures)

(Application money transferred to debenture account on allotment)

Example: A Company issued 2,000, 12% Debentures of Rs 100 each. The whole amount was payable on application. All the debentures were applied and duly allotted. Pass the necessary Journal entries in each of the following cases.
(a) Debentures were issued at par
(b) Debentures were issued at premium of Rs 10
(c) Debentures were issued at discount of Rs 10

Solution

Journal

Date

Particulars

L.F.

Debit

Amount

(Rs)

Credit

Amount

(Rs)

(a)

Bank A/c

Dr.

 

2,00,000

 

 

   To Debenture Application A/c

 

 

2,00,000

 

(Debenture application money received on 2,000 debentures at Rs 100 per debenture)

 

 

 

         

 

Debenture Application A/c

Dr.

 

2,00,000

 

 

   To 12% Debentures A/c

 

 

2,00,000

 

(Application money transferred to Debentures Account)

 

 

 

Journal

Date

Particulars

L.F.

Debit

Amount

(Rs)

Credit

Amount

(Rs)

(b)

Bank A/c

Dr.

 

2,20,000

 

 

   To Debenture Application A/c

 

 

2,20,000

 

(Debenture application money received on 2,000 debentures at Rs 110 per debenture)

 

 

 

         

 

Debenture Application A/c

Dr.

 

2,20,000

 

 

   To 12% Debentures A/c

 

 

2,00,000

     To Securities Premium A/c     20,000

 

(Application money transferred to Debentures Account)

 

 

 

Journal

Date

Particulars

L.F.

Debit

Amount

(Rs)

Credit

Amount

(Rs)

(c)

Bank A/c

Dr.

 

1,80,000

 

 

   To Debenture Application A/c

 

 

1,80,000

 

(Debenture application money received on 2,000 debentures at Rs 90 per debenture)

 

 

 

         

 

Debenture Application A/c

Dr.

 

1,80,000

 

  Discount on Issue of Debentures A/c Dr.   20,000  

 

   To 12% Debentures A/c

 

 

2,00,000

 

(Application money transferred to Debentures Account)

 

 

 


Instalment Issue (when amount is payable in instalments)

Instead of calling for the whole amount of debentures at the time of application, a company can generally prefers to call the debenture money over different instalments. These instalments are known as application, allotment, first call, second call and third call. 

Note:

  1. Students may find that the Journal entries in case of issue of debentures are similar to that of in case of issue of shares. The only difference between the two is that instead of Shares Application, Allotment and Share First Call, Debentures Application, Debenture Allotment and Debenture First Call and so on is mentioned. 
  2. Also, debentures are always preceded  by the percentage rate of interest such as 12% Debentures, 20% Debentures, etc.   

The following Journal entries are passed in case of issue of Debentures.

At the time of Application

Bank A/c

Dr.

To Debentures Application A/c

(Amount received on application)

Debenture Application A/c

Dr.

To __ % Debentures A/c

(Application money transferred to debenture account on allotment)

At the time of Allotment

Debentures Allotment A/c  

Dr.

To __ % Debentures A/c

(Money due on allotment)

Bank A/c

Dr.

To Debenture Allotment A/c

(Amount received on allotment)

At the time of Calls

Debenture First/Second/Third Call A/c

Dr.

To __ % Debentures A/c

(Money due on First/Second/Third Call)

Bank A/c

Dr.

To Debenture First/Second/Third Call A/c

(Amount received on First/Second/Third Call)

Instalment Issue at Par

Example: PQR Ltd issued 1,000, 11% Debentures of 100 each payable Rs 20 on application, Rs 50 on allotment and remaining amount on first and final call. All the debentures were the applied and duly allotted. Pass the necessary Journal entries.

Solution

PQR Ltd. 

Journal 

Date

Particulars

L.F.

Debit

Amount

Rs

Credit

Amount

Rs

 

Bank A/c

Dr.

 

20,000

 

 

   To Debenture Application A/c

 

 

20,000

 

(Debenture application money received on 1,000 debentures at Rs 20 per debenture)

 

 

 

 

Debenture Application A/c

Dr.

 

20,000

 

 

   To 11% Debentures A/c

 

 

20,000

 

(Application money transferred to  debentures account)

 

 

 

 

Debenture Allotment A/c

Dr.

 

50,000

 

 

   To 11% Debentures A/c

 

 

50,000

 

(Allotment money due on 1,000 11% Debentures of Rs 50 per debenture)

 

 

 

 

Bank A/c

Dr.

 

50,000

 

 

   To Debenture Allotment A/c

 

 

50,000

 

(Debenture allotment money received)

 

 

 

 

Debenture First and Final Call A/c

Dr.

 

30,000

 

 

   To 12% Debentures A/c    

 

 

30,000

 

(Debenture first and final call due1,000 11% Debentures of Rs 30 per debenture)

 

 

 

 

Bank A/c

Dr.

 

30,000

 

 

   To Debenture First and Final Call A/c

 

 

30,000

 

(Debenture First and Final call received)

 

 

 

Example: Hanisha Ltd. issued 7,500, 12% debentures of Rs 50 each payable Rs 20 on application, Rs 15 on allotment and remaining balance on first and final call. All the debentures were fully subscribed and all the money was duly received. Pass the necessary Journal entries.

Solution

Hanisha Ltd.

Journal

Date

Particulars

L.F.

Debit

Amount

Rs

Credit

Amount

Rs

 

Bank A/c

Dr.

 

1,50,000

 

 

   To Debenture Application A/c

 

 

 

1,50,000

 

(Amount received on application of 7,500 debentures at Rs 20 per debenture)

 

 

 

 

 

Debenture Application A/c

Dr.

 

1,50,000

 

 

   To 12% Debenture A/c

 

 

 

1,50,000

 

(Application money transferred to debentures account)

 

 

 

 

 

Debenture Allotment A/c

Dr.

 

1,12,500

 

 

   To 12% Debenture A/c

 

 

 

1,12,500

 

(Amount due on allotment of 7500 debentures at Rs 15 per debenture)

 

 

 

 

 

Bank A/c

Dr.

 

1,12,500

 

 

   To Debenture Allotment A/c

 

 

 

1,12,500

 

(Amount received on allotment of debentures)

 

 

 

 

 

Debenture First and Final call A/c

Dr.

 

1,12,500

 

 

   To 12% Debenture A/c

 

 

 

1,12,500

 

(Amount due on first and final call of 7,500 debentures at Rs 15per debenture)

 

 

 

 

 

Bank A/c

Dr.

 

1,12,500

 

 

   To Debenture First and Final Call A/c

 

 

 

1,12,500

 

(Amount received on call)

 

 

 

 


Instalment Issue at Premium

Example: Heena Ltd issued 3,000, 9% debentures of 50 each at a premium of 20% payable as follows- Rs 20 on application Rs 30 on allotment (including premium) and balance on first and final call. All the debentures were applied and allotted. Also, all the money due was duly received. Pass the necessary Journal entries.

Solution

Heena Ltd.

Journal

Date

Particulars

L.F.

Debit

Amount

Rs

Credit

Amount

Rs

 

Bank A/c (3,000 debentures × Rs 20)

Dr.

 

60,000

 

 

   To Debenture Application A/c

 

 

 

60,000

 

(Application money received on 3,000 debentures at Rs 20 per debenture )

 

 

 

 

 

Debenture Application A/c

Dr.

 

60,000

 

 

   To 9% Debenture A/c

 

 

 

60,000

 

(Application money transferred to debentures account)

 

 

 

 

 

Debenture Allotment A/c (3000 debentures × Rs 30)

Dr.

 

90,000

 

 

   To 9% Debenture A/c (3000 debentures × Rs 20)

 

 

 

60,000

 

   To Securities Premium A/c (3000 debentures × Rs 10)

 

 

 

30,000

 

(Allotment money due on 3,000 debentures at Rs 30 including premium of 10% i.e. Rs 10 per debenture)

 

 

 

 

 

Bank A/c

Dr.

 

90,000

 

 

   To Debenture Allotment A/c

 

 

 

90,000

 

(Amount received on allotment)

 

 

 

 

 

Debenture First and Final Call A/c

Dr.

 

30,000

 

 

   To 9% debenture A/c

 

 

 

30,000

 

(Amount due on first and final call of 3,000 debentures at Rs 10 per debenture)

 

 

 

 

 

Bank A/c

Dr.

 

30,000

 

 

   To Debenture First and Final Call A/c

 

 

 

30,000

 

(Amount received on call)

 

 

 

 

Instalment Issue at Discount

Example: Archana Ltd. issued  4,500, 8% debentures of Rs 50 each at a discount of 10% payable as Rs 15 on application, Rs 20 on allotment and balance on first and final call. Pass the necessary Journal entries.

Solution

Archana Ltd.

Journal

Date

Particulars

L.F.

Debit

Amount

Rs

Credit

Amount

Rs

 

Bank A/c (4,500 debentures × Rs 15)

Dr.

 

67,500

 

 

   To Debenture Application A/c

 

 

 

67,500

 

(Application money received on 4,500 debentures at Rs 15 per debenture )

 

 

 

 

 

Debenture Application A/c

Dr.

 

67,500

 

 

   To 8% Debenture A/c

 

 

 

67,500

 

(Application money transferred to debentures account)

 

 

 

 

 

Debenture Allotment A/c (4,500 debentures × Rs 20)

Dr.

 

90,000

 

 

Discount on Issue of Debenture A/c (4,500 debentures × Rs 5)

Dr.

 

22,500

 

 

   To 8% Debenture A/c (4,500 debentures × Rs 25)

 

 

 

1,12,500

 

(Allotment money due on 4,500 debentures at Rs 20 per debenture at a discount of Rs 5 )

 

 

 

 

 

Bank A/c

Dr.

 

90,000

 

 

   To Debenture Allotment A/c

 

 

 

90,000

 

(Amount received on allotment)

 

 

 

 

 

Debenture First and Final Call A/c (4500 debentures × Rs 10)

Dr.

 

45,000

 

 

   To 8% Debenture A/c

 

 

 

45,000

 

(Amount due on call of 4,500 debentures at Rs 10 per debenture )

 

 

 

 

 

Bank A/c

Dr.

 

45,000

 

 

   To Debenture First and Final Call A/c

 

 

 

45,000

 

(Amount received on call)

 

 

 

 

Objective

After going through this lesson, you shall be able to understand the following concepts of Issue of Debentures for Consideration other than Cash. 

  • Issue of Debentures for Purchase of Assets
  • Issue of Debentures for Purchase of Business
  • Issue of Debentures for Purchase of Services

Issue of Debentures for Consideration other than Cash

Generally, a company issues its debentures for a cash consideration (that is debentures issued for cash). It implies that the debentures are issued by a company for raising its capital in the form of cash. But, it is not always necessary that a company will issue debentures for cash. Debentures can also be issued for consideration other than cash. Sometimes, when a company purchases assets from its suppliers or vendors it issues debentures  to them instead of making payment in cash. In such a situation, the debentures  are said to be issued against the purchase of assets. Moreover, there are times, when a company purchases the whole business of some other firm. For example, Company A Ltd. purchased the business of Company B Ltd. The purchase of business implies purchase of all the assets and liabilities. In this case, the company can issue debe...

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