Issue of Debentures, Meaning, Objectives, Types, Methods and Accounting Entries for the Issue of Debentures with Explicit Conditions of Redemption
by Issue of debentures refers to the process by which a company raises borrowed capital from investors by issuing debt instruments. A debenture represents a form of debt under which the company agrees to repay the principal amount according to specified terms and usually pays interest at an agreed rate. Debentures may be issued to the public, financial institutions, or selected investors. Unlike equity shares, debentures generally do not provide ownership rights or voting rights. They are an important source of long-term finance for business expansion, purchasing assets, refinancing existing debts, and meeting other financial requirements.
Objectives of Issuing Debentures
1. Raising Long-Term Capital
Companies issue debentures to raise substantial long-term funds for business activities and development projects. These funds can be used to purchase machinery, construct buildings, establish factories, and expand existing operations. Debentures provide an alternative to equity financing and help companies obtain capital without immediately issuing additional shares. The repayment period and interest rate are generally specified in advance, allowing companies to plan their financial requirements and organise investments according to their expected cash flows and business objectives.
2. Maintaining Ownership and Control
One important objective of issuing debentures is to raise funds without diluting the ownership interests of existing shareholders. Debenture holders are creditors rather than owners and generally do not possess voting rights in ordinary shareholder decisions. Consequently, companies can obtain additional finance while maintaining the existing distribution of voting power. This is particularly useful when promoters wish to retain control over business decisions. However, excessive borrowing may increase financial risk and create pressure on the company’s repayment capacity.
3. Financing Business Expansion
Companies issue debentures to finance expansion plans, such as opening new branches, entering new geographical markets, increasing production capacity, and developing new products. Expansion often requires substantial investment that may exceed internally generated funds. Debenture financing provides an opportunity to obtain the necessary resources while spreading repayment over an agreed period. If the expansion generates sufficient income, the company may meet its interest obligations and improve profitability. Therefore, debentures can support planned growth and strengthen long-term business operations.
4. Diversification of Financing Sources
Issuing debentures enables companies to diversify their financing sources instead of depending entirely on equity shares, retained earnings, or bank loans. A balanced financing structure may improve financial flexibility and provide alternatives when particular funding sources become expensive or unavailable. Companies can select suitable maturity periods, interest rates, and security arrangements according to their requirements. Diversification also helps management compare financing costs and risks. However, borrowing decisions should consider existing liabilities and ensure that additional debt remains financially sustainable.
5. Taking Advantage of Financial Leverage
Companies may issue debentures to benefit from financial leverage, which arises when borrowed funds are used to generate returns for shareholders. If the return earned on investments financed through debentures exceeds the effective cost of borrowing, shareholders may benefit from increased earnings. Interest expenses may also be tax-deductible where permitted by applicable tax law. Nevertheless, leverage increases financial risk because interest and principal obligations remain payable even during periods of weak profitability, making careful financial planning essential.
6. Meeting Working Capital Requirements
Although debentures are often associated with long-term investment, suitable debt instruments may also help companies finance ongoing operational requirements. Businesses need funds to purchase inventory, pay suppliers, meet operating expenses, and manage temporary cash-flow shortages. Depending on the instrument’s maturity and issue terms, debenture proceeds can supplement other working capital sources. Companies should match the duration of borrowing with the purpose for which funds are required and avoid using long-term debt inefficiently or accumulating excessive financial obligations.
7. Refinancing Existing Borrowings
Companies may issue new debentures to refinance existing loans or debt instruments when refinancing is financially beneficial and legally permitted. The objective may be to obtain a lower interest rate, extend repayment periods, improve cash-flow management, or consolidate multiple borrowing arrangements. Refinancing can reduce immediate repayment pressure and provide greater financial flexibility. However, the company must evaluate transaction costs, redemption conditions, market interest rates, and the terms of the new debt before deciding whether refinancing will improve its overall financial position.
8. Supporting Financial Planning and Stability
Debentures help companies plan their financial activities because the principal repayment schedule and interest obligations are generally established in advance. Predictable payment terms can assist management in preparing budgets, forecasting cash flows, and allocating resources to business projects. Debentures may also provide an alternative to issuing equity when management wants to preserve ownership percentages. However, financial stability depends on borrowing at a sustainable level, maintaining sufficient liquidity, and ensuring that the company can meet its contractual debt obligations under changing business conditions.
Types of Debentures
1. Secured Debentures
Secured debentures are debt instruments backed by a charge on specified assets of the issuing company. If the company defaults, debenture holders may have rights over the secured assets, subject to the security documents and applicable law. These debentures generally provide greater protection than comparable unsecured debentures. Companies issuing secured debentures must comply with applicable requirements relating to the creation and registration of security.
Example: ABC Limited issues debentures worth ₹10,00,000 secured by a charge over its factory building and machinery.
2. Unsecured Debentures
Unsecured debentures are not backed by a specific charge over company assets. Investors rely primarily on the company’s creditworthiness, financial position, and contractual promise to repay the borrowed amount. Since these debentures lack specific asset security, they may carry greater credit risk than comparable secured instruments. Their interest rates depend on the issuer’s reputation, credit rating, market conditions, and repayment period.
Example: XYZ Limited issues unsecured debentures worth ₹5,00,000 based on its financial strength and repayment commitment.
3. Convertible Debentures
Convertible debentures are debt instruments that can be converted into equity shares according to predetermined conditions. Conversion may be compulsory or optional, depending on the issue terms. These instruments allow companies to raise funds initially as debt while potentially converting the liability into equity later. Investors may benefit from future growth if the conversion results in valuable share ownership.
Example: PQR Limited issues ₹1,00,000 in convertible debentures, which may be converted into 1,000 equity shares under the stated terms.
4. Non-Convertible Debentures
Non-convertible debentures cannot be converted into equity shares under their issue terms. They remain debt obligations until repayment or redemption. Investors generally receive interest at an agreed rate and repayment of principal according to the specified schedule. Companies use these instruments to raise funds without creating future equity dilution through conversion.
Example: LMN Limited issues 1,000 non-convertible debentures of ₹1,000 each, repayable after five years.
5. Redeemable Debentures
Redeemable debentures are repaid by the company after a specified period or according to an agreed redemption schedule. Their terms state when the principal becomes payable and whether redemption occurs at par or at a premium. They help companies plan borrowing for a defined period and allow investors to understand when their principal is expected to be returned.
Example: ABC Limited issues debentures worth ₹8,00,000, redeemable at par after five years.
6. Perpetual Debentures
Perpetual debentures have no fixed maturity date for repayment of principal, subject to their terms and applicable law. Investors may receive interest for an extended period, while the principal is not scheduled for repayment on a conventional maturity date. These instruments can provide long-term capital to the issuer but may expose investors to greater uncertainty regarding repayment.
Example: A company issues perpetual debentures worth ₹2,00,000 with interest payable annually under the issue terms.
7. Registered Debentures
Registered debentures are recorded in the company’s register of debenture holders. The company maintains details of the holders and makes payments to the persons entitled under the records and applicable law. Transfers are handled through the prescribed procedures. Registration helps establish ownership records and facilitates communication between the company and debenture holders.
Example: DEF Limited issues registered debentures to 100 investors and records their names and holdings in its register.
8. Bearer Debentures
Bearer debentures are traditionally defined as instruments payable to the person who holds them, with ownership transferred through delivery. They do not rely on a conventional registered-holder record in the same way as registered debentures. Their treatment depends on the applicable legal framework, and bearer-style instruments may be restricted or unavailable under modern company and securities laws.
Example: In a traditional textbook illustration, a bearer debenture is transferred by delivering the instrument to another person. This is a conceptual example, not a statement that every company may issue such instruments today.
Methods of Issuing Debentures with Examples
1. Issue of Debentures at Par
Debentures are issued at par when the issue price equals their nominal or face value. The company receives an amount equal to the principal value of the debt created. This is one of the simplest methods of issuing debentures because there is no issue premium or discount. The company records the cash received and recognises the debenture liability at its nominal value.
Example: ABC Limited issues 1,000 debentures of ₹100 each at par.
Total proceeds = 1,000 × ₹100 = ₹1,00,000.
Journal entry:
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank A/c Dr. | 1,00,000 | — |
| To Debentures A/c | — | 1,00,000 |
2. Issue of Debentures at a Premium
Debentures are issued at a premium when their issue price exceeds their nominal value. The additional amount received over the face value is the premium. The premium is recorded separately according to applicable accounting requirements. Companies may be able to issue debentures at a premium depending on their creditworthiness, interest terms, and market conditions.
Example: XYZ Limited issues 1,000 debentures of ₹100 each at ₹105.
Total proceeds = 1,000 × ₹105 = ₹1,05,000.
Premium = 1,000 × ₹5 = ₹5,000.
Journal entry:
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank A/c Dr. | 1,05,000 | — |
| To Debentures A/c | — | 1,00,000 |
| To Premium on Issue of Debentures A/c | — | 5,000 |
3. Issue of Debentures at a Discount
Debentures are issued at a discount when their issue price is lower than their nominal value. The difference between the face value and the issue price represents the discount. The company receives less money initially but remains liable for the principal amount specified in the debenture terms. The discount is accounted for in accordance with applicable accounting standards.
Example: PQR Limited issues 1,000 debentures of ₹100 each at ₹95.
Total proceeds = 1,000 × ₹95 = ₹95,000.
Discount = 1,000 × ₹5 = ₹5,000.
Journal entry:
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank A/c Dr. | 95,000 | — |
| Discount on Issue of Debentures A/c Dr. | 5,000 | — |
| To Debentures A/c | — | 1,00,000 |
4. Issue of Debentures as Collateral Security
Debentures may be issued as collateral security to a lender against a loan or other borrowing. In this arrangement, the debentures provide additional security for the borrowing rather than necessarily representing funds received through a separate cash issue. Accounting treatment depends on the applicable accounting framework and the company’s chosen method.
Example: LMN Limited borrows ₹5,00,000 from a bank and provides debentures worth ₹6,00,000 as collateral security.
Under the traditional textbook method, no journal entry may be passed for the collateral issue; a note may instead be provided in the accounts. Under another accepted method, a Debenture Suspense Account may be used. The applicable accounting policy should be followed consistently.
5. Issue of Debentures for Consideration Other Than Cash
A company may issue debentures to purchase assets or acquire a business instead of paying the seller entirely in cash. The debentures serve as consideration for the assets or services acquired. The company records the acquired asset or liability and the debenture obligation according to the agreed transaction value and applicable accounting requirements.
Example: ABC Limited purchases machinery valued at ₹2,00,000 from a supplier and issues 2,000 debentures of ₹100 each as payment.
Journal entry:
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Machinery A/c Dr. | 2,00,000 | — |
| To Debentures A/c | — | 2,00,000 |
6. Issue of Debentures Redeemable at a Premium
A company may issue debentures that are repayable at an amount greater than their nominal value. The premium payable on redemption represents an additional contractual obligation and must be accounted for in accordance with the applicable accounting requirements. Investors may accept these terms in exchange for the expected return and repayment conditions.
Example: DEF Limited issues 1,000 debentures of ₹100 each, redeemable at a premium of 5%.
Nominal value = ₹1,00,000.
Redemption premium = ₹5,000.
Amount payable on redemption = ₹1,05,000.
The accounting entries at issue and for the redemption premium depend on the relevant accounting standards and the terms of issue.
Accounting Entries for the Issue of Debentures with Explicit Conditions of Redemption (at Par and Premium)
When a company issues debentures, the accounting entries depend on the issue price and the amount payable at redemption. Debentures may be issued at par or at a premium and may be redeemable at par or at a premium. The redemption conditions must be clearly stated because they determine the amount the company is required to repay to debenture holders.
1. Issue of Debentures at Par and Redeemable at Par
When debentures are issued at their face value and redeemed at the same value, the company receives an amount equal to the nominal value and repays the same amount at maturity.
Example: ABC Ltd. issues 1,000 debentures of ₹100 each at par, redeemable at par after five years.
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Face value: 1,000 × ₹100 = ₹1,00,000
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Issue proceeds: ₹1,00,000
-
Redemption amount: ₹1,00,000
Journal entry at the time of issue
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank A/c Dr. | 1,00,000 | — |
| To Debentures A/c | — | 1,00,000 |
| (Being debentures issued at par and redeemable at par) |
Journal entry at the time of redemption
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentures A/c Dr. | 1,00,000 | — |
| To Debentureholders A/c | — | 1,00,000 |
| (Being amount due to debenture holders on redemption) |
On payment:
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentureholders A/c Dr. | 1,00,000 | — |
| To Bank A/c | — | 1,00,000 |
| (Being redemption amount paid to debenture holders) |
2. Issue of Debentures at a Premium and Redeemable at Par
When debentures are issued at a premium, the issue price exceeds their face value. However, if they are redeemable at par, the company repays only the nominal value at maturity. The premium received on issue is credited to Securities Premium Account.
Example: XYZ Ltd. issues 1,000 debentures of ₹100 each at ₹110, redeemable at par after five years.
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Face value: 1,000 × ₹100 = ₹1,00,000
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Issue premium: 1,000 × ₹10 = ₹10,000
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Total proceeds: ₹1,10,000
-
Redemption amount: ₹1,00,000
Journal entry at the time of issue
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank A/c Dr. | 1,10,000 | — |
| To Debentures A/c | — | 1,00,000 |
| To Securities Premium A/c | — | 10,000 |
| (Being debentures issued at a premium and redeemable at par) |
Journal entry at the time of redemption
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentures A/c Dr. | 1,00,000 | — |
| To Debentureholders A/c | — | 1,00,000 |
| (Being amount due on redemption at par) |
Payment entry
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentureholders A/c Dr. | 1,00,000 | — |
| To Bank A/c | — | 1,00,000 |
| (Being redemption amount paid) |
3. Issue of Debentures at Par and Redeemable at a Premium
When debentures are issued at face value but are repayable at an amount higher than their face value, the additional amount is called the premium on redemption. This creates an additional obligation for the company and must be accounted for according to the applicable accounting standards.
Example: PQR Ltd. issues 1,000 debentures of ₹100 each at par, redeemable at a premium of 10%.
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Face value: ₹1,00,000
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Issue proceeds: ₹1,00,000
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Premium on redemption: ₹10,000
-
Redemption amount: ₹1,10,000
Journal entry at the time of issue
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank A/c Dr. | 1,00,000 | — |
| Loss on Issue of Debentures A/c Dr. | 10,000 | — |
| To Debentures A/c | — | 1,00,000 |
| To Premium on Redemption of Debentures A/c | — | 10,000 |
| (Being debentures issued at par but redeemable at a premium) |
Journal entry when redemption becomes due
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentures A/c Dr. | 1,00,000 | — |
| Premium on Redemption of Debentures A/c Dr. | 10,000 | — |
| To Debentureholders A/c | — | 1,10,000 |
| (Being redemption amount, including premium, due to debenture holders) |
Payment entry
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentureholders A/c Dr. | 1,10,000 | — |
| To Bank A/c | — | 1,10,000 |
| (Being redemption amount paid) |
Note: The debit used to recognise the redemption premium at issue may be described and presented differently depending on the applicable accounting framework and the company’s circumstances. Follow the prescribed accounting treatment.
4. Issue of Debentures at a Premium and Redeemable at a Premium
In this method, the company receives more than the face value when issuing debentures and must also repay more than the face value at maturity. The issue premium and redemption premium are separate items: the first is received from investors, while the second is payable to them.
Example: LMN Ltd. issues 1,000 debentures of ₹100 each at ₹105, redeemable at a premium of 5%.
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Face value: ₹1,00,000
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Premium on issue: ₹5,000
-
Total proceeds: ₹1,05,000
-
Premium on redemption: ₹5,000
-
Redemption amount: ₹1,05,000
Journal entry at the time of issue
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank A/c Dr. | 1,05,000 | — |
| Loss on Issue of Debentures A/c Dr. | 5,000 | — |
| To Debentures A/c | — | 1,00,000 |
| To Securities Premium A/c | — | 5,000 |
| To Premium on Redemption of Debentures A/c | — | 5,000 |
| (Being debentures issued at a premium and redeemable at a premium) |
Journal entry when redemption becomes due
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentures A/c Dr. | 1,00,000 | — |
| Premium on Redemption of Debentures A/c Dr. | 5,000 | — |
| To Debentureholders A/c | — | 1,05,000 |
| (Being redemption amount due) |
Payment entry
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Debentureholders A/c Dr. | 1,05,000 | — |
| To Bank A/c | — | 1,05,000 |
| (Being redemption amount paid to debenture holders) |
Important accounting note: The debit labelled “Loss on Issue of Debentures” in the examples involving redemption premium is a simplified textbook presentation. The appropriate recognition and subsequent treatment of issue costs or redemption premiums must follow the applicable accounting standards and the terms of issue.