What is a Accounting for Debentures? Differences between shares and debentures, Types of debentures

What  is a Accounting for Debentures?  Differences between shares and debentures, Types of debentures 

What  is a Accounting for Debentures?

Accounting for Debentures

Introduction
The total capital of a joint stock company is classified into owner's capital and borrowed capital. Share capital is owner's capital whereas debenture is borrowed capital. Debenture is a long-term loan. Companies can raise additional capital by the issue of debentures. Debenture holders receive fixed income in the form of interest during the loan period; however, they do not possess the voting right as the shareholders.

Meaning of debentures
Debenture is a written promise for a debt by a company under its seal which contains the terms and conditions regarding the amount of loan or principle, the rate of interest, maturity date, maturity value, etc. in other word's a debenture is a certification of acknowledgement issued with the of company in favor of ledger as an evidence of debt. This written document grants the holder the right to receive interest and return of principal as per the terms under which debentures are issued. Nepal company act 2063 defines debenture as the instrument issued by a company against mortgage or without mortgage of property."

Thus, debenture is a part of total capital of a company and debenture holders are the creditors. Debenture holders are entitled the right to receive interest on their fund invested in debentures. The rate of interest is pre-determined and stated in the bond certificate. The interest is payable whether there is profit or loss. The amount of debenture is returned to the holders at the end of predetermined maturity period.
Characteristics if debentures
Issue of debenture is an importance source of capital for a company. A debenture of company possesses the following characteristics:
1.    Written promise: it is a written promise issued to the lender that the states the payment of the value of loan in a specified period of time.
2.    Face value: a debenture has a fixed face value. It is generally Rs2, 000.
3.    Rate of interest: the rate of interest is fixed and paid every year. So, debentures is also known as "fixed cost bearing capital."
4.    Maturity period: debenture is redeemable (payable) at a fixed and specified period of time which is called maturity period.
5.    Long term: it is a form of long-term borrowed capital.
6.    Common seal: it has common seal of the company.
7.    Collateral: Debentures are issued against certain collateral as land, building, equipment.
8.    Voting right: debenture holders have no right to cost vote in company's general meeting.
9.    Preference: at the time of liquidation, first priority is given to the debenture holders at the time of repayment.
Importance of Debentures
An issue of debenture plays an important role in long-term planning and decision-making. In modern competitive business era, every company needs fund for any business opportunity. This financing can be fulfilled only by issuing owner's capital and debt capital. The issue of debenture, in one side creates the obligation for the payment of interest at a fixed rate and in another side, it cause and increase in earnings per share' due to comparatively less number share issued. The following point's are produced for its importance:
1.    Debentures serve as long term source of financing for a company.
2.    It is a low cost course of financing since the interest to be paid to the debenture holders is generally less than the dividend.
3.    The interest is subtracted from the taxable income. Hence, it reduces the tax burden.
4.    It provides way to leverage the capital structure of a company.
Differences between shares and debentures
The differences between shares and debenture are presented below.
Basis of difference    shares    Debentures
Ownership    The share of a company provides ownership to the shareholders.    The debenture holders provide loan. Thus, debenture holders are creditors of a company.
Identify    Person holding shares is known as shareholder.    Person holding debenture is known as debenture holders.
Certainty of return    No certainty of return is case of loss.    The rate of interest is fixed and is to be paid specified period.
Repayment    Repayment if the company liquidates and fund are available.    Repayment during its lifetime or at the specified period.
Convertibility    Shares can't be converted into debenture    Debenture holder can be converted into shares.
Control    Shareholders have the right to participate and vote in company’s meeting.    Debenture holders do not possess any voting rights and can't participate in meetings.

Types of debentures
The major type's debentures are presented in the following figure:

On the basis of record
1.    Registered debentures. Registered debentures are those debentures which are register in the name of the holder by the company in the registered in the name of the holder by the company In the register of debenture holders. Such debentures are issued in the name of the holder, which appear in the debenture certificate. Interest on such debenture is payable to the person whose name is registered with the company. This debenture is transferable in the manner as share by transfer deeds.
2.     Bearer debentures. Bearer debentures are those which are not recorded in the company's register. These debentures are not transferable by mere delivery. Payment of interest is made on the submission of coupons attached to the debenture.
On the basis of security
1.    Secured debentures. The secured debenture may be fully secured or unsecured. Secured debentures are those debentures which are secured either by the mortgage of particular assets of the company, known as 'fixed charge' or by the mortgage of general assets, known as 'floating charge'.
2.    Unsecured or naked debenture. Unsecured debentures are those debentures which are not secured by any charge or mortgagee or mortgage on any property of the company. Therefore, this type of debenture is also known as 'naked debentures'. Only reputed company, whose financial position is strong, can issue such naked debenture.
On the basis of redemption
1.    Convertible debenture. Convertible debentures are those debenture are issued for a specified period after which the company must repay the amount of debenture on a specified date or after notice or by periodical drawings.
2.    Irredeemable or perpetual debenture. Irredeemable debentures are those debentures for which no fixed date is specified for repayment and them payable of debentrehoders or at the option. Of the company. T may be fully convertible debenture or partly convertible debentures.
On the basis of convertibility
1.    Convertible debenture. Convertible debentures are those debentures which are convertible into equity shares or other securities either at the option of debenture holder or at the option of the company. It may be fully convertible debentures or partly convertible debentures.
2.    Non-convertible debentures. Non-convertible debentures are those debentures which cannot be converted into shares or any other securities.

On the basis of priority
1.    First debenture. The debenture which has the first priority for claim over other debentures for the payment out of the mortgage properly is called first debenture.
2.    Second debenture. This debenture is payable only after the payment or satisfaction of first debenture.
Accounting entries for the issue of debentures
 The procedure and accounting entries for issue of debentures are very much similar to that of shares. A prospectus is issued to the public for inviting applications. The money on debentures may be payable in full at a time along with application or by installments on application, allotment and various calls.

There is no legal restriction on the price for which debentures are issued. Thus, a debenture may be issued at par, at premium or at a discount. They can be issued for debentures with redeemable conditions.
Lets us study the accounting entries passed in these entire different situation for issue of debentures, which are as follows:
 Issue of debentures for cash
Issue of debentures at lump sum
The money on debenture can be received in lump sum instead of different installments. The entries for the issue of debenture on lump sum basis are as below:
Issue of debentures in redeemable condition
Redemption of debentures means discharge of liabilities on account of debentures by repayment of the principal amount to debenture holders. Debentures may be redeemed either at par, premium or as per the term and condition of the issue of debentures:

The debentures may be issued by a company from redemption point of view at various terms. These terms may not be only related to the issue of debentures but also to their redemption. For example, just as the issue of debentures may take place at par, at a premium or at discount, where the redemption also can be stipulated at par, at a premium or at a discount. In practice, however, the redemption is never made at a discount. Thus, combining such terms of issue and redemption of debenture, the following possibilities are commonly found in practice.
Issue of debentures in installment
Debentures may be issued at par, at premium or at discount, just like issue of shares. The entries for accounting remain the same as in the issue of shares. From the accounting point of view, the premium is capital profit and not to be utilized for payment of dividend.
a.    Issue of debentures at par
When debenture are issued at the face value, it is called issue of debenture at par. The money on debentures can be received in lump sum or in various installments. The entries for the issue of debenture in installment.
b.    Issue of debentures at premium
When debentures are issued at a price more than the face value (nominal value), then they are said as issue at premium. It is a capital profit. It is utilized to write off fictitious assets.
c.    Issue of debenture at discount
When debentures are issued at a price, which is less than its nominal or face value, they are said to be issued at discount. The board of directors decides about the amount of discount and the discount is a loss to the company. So it is a capital loss and shown in the 'assets' side of balance sheets under the sub head miscellaneous expenditures.
Calls in arrears
The unpaid amount on allotment and calls are kept in a separate account, named as 'calls-in arrear a/c'. This amount represents the call money not received by the company. It shows a debit balance (as asset) and it reduces the face value of debentures (paid up value).
Calls in advance
When a company accepts money paid by some debenture holder in respect of calls not yet due, is known as 'calls in advance'. It is liability of the company. It is adjusted when the respective call is received.
Issue of debentures for other than cash
Sometimes debentures are issued for consecration other than cash; such as issue of debenture to the vendor. As and when assets are purchase or a running business is taken over by the company, the company may agree to issue debentures in lieu (manner) of share or cash to the vendor. Such issue is called as "issue debentures for consideration other than cash.
Issue of debentures for the purchase of assets
When the asset is purchase and decided to issue debenture for the same, the following entries are passed.
Issue of debentures for the purchase of business
When the business is purchase i.e. both assets and liabilities and decided to issue debentures for the same, the following entries are passed.
Issue of debentures as a collateral security
Issue of debenture as collateral security means issue of debenture as a secondary or subsidiary security. Collateral security means additional security, i.e. in addition to the principle security.
When a company takes loan from a bank or from financial institutions, then the issue of debentures as secondary security to the bank against security of loan will take place. If the loan is paid back, those debentures are returned by bank to the company. Such a collateral security is to be realized only when principal security fails to pay the amount of loan. No interest is paid on the debentures issued as a collateral security.
If a company fails or makes default in the repayment of the loan, the loan creditor will become the debenture holders
Accounting treatment
There are two methods to deal in the books;
a.    First method
No entry is made for issue of debenture but only a note is given in the balance sheet towards debentures issued as collateral security as shown below:
b.    Second method
An accounting journal entry is passed for issue of debenture as collateral security, which is as under: 

Amortization of discount on issue of debentures
Discount on issue debentures, or any loss on issue of debentures (redeemable premium) is a capital loss. It is fictition assets and shown in the assets side of the balance sheet. This discount or loss on issue of debentures must be written off as possible against capital profit or by debentures the profit and loss account. The entry for writing off the loss is as follows:

The amount to be written off depends on how the debentures are redeemed. The debentures can be redeemed either after a fixed period or in installments. Thus the following two methods for writing off discount are presented as follows:
a.    Fixed installment method
If the debentures are written after a fixed period, the amount of discount can be equally apportioned to different years of debentures in order to written off.
b.    Fluctuating installment method
According to this method, the debenture discount will be written off each year in proportion to the amount of debentures outstanding in the beginning of the year. Hence, this method is also knows as "proportion method".
Redemption of debentures :Debentures are the loan for a company. It is a liability and has to be paid at maturity period. Redemption of debentures means repayment of the amount of the debentures. Generally, it is discharged or paid at the expiry of the period, for which, it is originally issued. Normally, the time and period and mode of repayment are indicated in the prospectus at the time of issue of debentures by a company. There are a number of methods by which the debentures can be redeemed or repaid. These are as follows:
Lump sum cash payment method or redemption on maturity
As mentioned earlier, the debentures are issue for a specified period of time. After expire of the period, the whole amount of debentures is paid back to the debenture holders at once in lump-sum. The debenture may be redeemed at par, at a premium or at discount, as previously explained. The entries are as follows:
Redemption be conversion into shares and new debentures
Conversion of debentures into shares will take place only in case of convertible debentures. No-convertible debentures cannot be converted into shares as per the rule prescribed by the controlled of capital issue. The conversion into shares may be be optional or compulsory depending upon the term at which convertible debentures had been issued. While converting the old debentures into shares or new debentures, the shares may be issued at par, at a premium or at a discount. The following entries are passed for conversion.
Redemption in installments or draw by lot method
Under this method, the company redeems its debentures be payment each year of a certain installment amount. The debentures may be repaid by selecting lottery system and this procedure is called "drawing by lot" method.
Redemption by purchase in the open market
The company can also redeem its debentures by purchasing own debenture in the open market. It can be done only if the article of association of the company permits so. The companies usually purchase its own debentures from the market when they are available in the market at a price, which is less than its par value and earns the amount of profit. The profit earned on cancellation of old debentures is transferred to "capital" reserve account."
Review of theoretical concept
1.    What is 'debenture'?A debentures is document, which refers to an undertaking of the company in writing for acknowledging a debt and containing a contract of the repayment of the principle sum at a specified period and for the payment of interest at a fixed rate. So, a debenture represents a debt.
2.    Mention any two futures of debentures.
Following are the feature of debentures:
a.    Written promises: it contains a promise to repay the principal amount after a stipulated period. It is a written document of loans issue by a company to its holders. It also contains a promise of periodic payment of interest at a fixed rate.
3.    Give any two differences between share and debenture.
The following are two different between share and debenture:
a.    Ownership: a shareholder is owner of the company but the debentures is the creditor of the company.
b.    Voting right: Shareholders generally have voting right but debentures holder do not have voting right.
4.    What is meant by convertible debentures?
The debentures are partly or fully convertible into share of the company as per share the terms of their issue in convertible debentures. Generally, the terms and conditions of conversion are announced at the time of issue of debenture.
5.    Mention the different types of debentures.
The various types of debentures are follows:
a.    Secured debenture
b.    Unsecured debenture
c.    Redeemable debenture
d.    Non-redeemable debenture
e.    Registered debenture
f.    Bearer debenture
g.    Convertible debenture
h.    Non-convertible debenture