Notes, Exercises, Videos, Tests and Things to Remember on Accounting for Debentures
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Things to remember
The joint stock company may require money for its expansion and development. This requirement may be met by the company by public borrowings. A debenture is one of the ways of the public borrowing. The issue of debentures helps the company in borrowing the bulk amount of debts from the large section of the general public. A debenture is a document that recognizes such public borrowing.
A debenture is a certificate issued by a company acknowledging a debt of a specified amount of public borrowing. It is a portion of loan capital. A debenture is also known as bond. The owners of debentures are called debenture holders. They are the creditors of the company and are entitled to receive an agreed and fixed rate of interest on their debentures regularly. Debentures carry interest periodically at a certain rate.
The Oxford Advanced Learner’s Dictionary has defined debenture as “ An official document that is given by a company, showing it has borrowed money from a person and stating the interest payments that it will make to them.
A debenture is a loan certificate issued by the company to its holders under the company seal. The company instead of borrowing entire monetary requirement from a financial institution may obtain it from the large section of the general public by issuing certificate acknowledge debts. The borrowing is called debentures.
Features of Debentures
The following are the main features of debenture:
It is a written certificate issued by the company as an acknowledgement of a debt.
It is issued under the company’s seal.
It contains the rate of interest to be paid to the subscribers.
It contains the mode of payment of the large section of the general public.
Types of Debenture
Debenture can be classified into different types on the basis of terms and conditions of issue. The different types of debentures issued by a company are as follow:
Registered debenture: A debenture that cannot be transferred by a mere physical delivery is called registered debenture. The name of the holder of such debenture is registered with the company.
Bearer Debenture: The debenture which is transferable by a mere delivery is called bearer debenture. The holders of such debentures are its owner and are called debenture holders.
Irredeemable debenture: A debenture which is issued without any maturity period is known as an irredeemable debenture. This type of debentures is also called perpetual debenture. The sum of the debenture is repaid to the debenture holders after the expiry of the period specified at the time of issue.
Convertible debenture: A debenture which is issued with an option of being converted it into common share, preference share or new debentures within a specified period at a conversion ratio is called convertible debenture.
Non-convertible debenture: The debentures, which have no option of being converted into equity or preference share or new debentures are called non-convertible debenture.
Secured debenture: A debenture which is issued against a specific fixed assets as security is called secured debenture. Upon default of such debenture in due data, the debenture holder can realize their sum out of the sale realized from such fixed assets. Secured debentures are also called mortgaged debentures.
Unsecured (naked) debenture: Debentures issued without any security are called unsecured debentures. The holders of such debentures are not given any security for the issue of such debentures. The holders of such debentures are treated as the general creditors of the company.
First debenture: A debenture which is issued against a specific fixed asset not currently pledge as a security for the issue is called the first debenture. Such debentures need to be repaid fully before second debentures are issued.
Second debenture: A debenture which is issued against a specific fixed asset already used as a security is known as the second debenture. Such debentures are repaid only after the first debenture have been fully settled.
Collateral Debenture: Debenture may also be issued to money lenders, i.e to the banks and financial institutions as an additional security along with the principal security for the sanction of the bulk amount of loan. Such debentures are called collateral debentures. The money lenders can exercise its rights as debenture holders if issuing company fails to pay the loan amount and principal security falls short to recover the loan.
(Koirala, Shrestha, and Singh)
Importance of Debenture
An issue of debenture plays a great role in long-term planning and decision-making inside the organization. In modern competitive business age, every company requires a fund to start any business or for any business opportunity. This financing can be fulfilled only by issuing owner's capital and debt capital. The issue of a debenture, on one side, creates the obligation for the payment of interest at a fixed rate and in another side, it causes an increase in ' earning per share' due to comparatively less number of shares issued. (Account management)
Debentures as a source of finance activity companies which have regular earnings to service the debt have a higher proportion of fixed assets in their assets structure which offers adequate security and motivates investors. The company has to ensure maintenance of discrete debt equity ratio.
Support from investment institutions is sufficiently available.
Debenture holders receive a fixed rate of return on their investment.
Institutional underwriters, merchant banks in public and private sector have come up to render successful underwriting services to the investor as well as the needy companies;
Investor’s preference to high yielding securities with minimum risk has encouraged issue of debentures by the companies.
The cost of raising money through debenture is minimum as against the cost involved in other sources of finance.
Debenture issuing company is obliged now to create a debenture redemption fund to protect the interest of debenture holders.
Debentures are transferable from one person to another. (Money matter)
Advantages of Debentures
The issue of debenture does not result in dilution of interest of equity shareholders as they do not have right either to vote or take part in the management of the company.
Interest on debenture is a tax deductible expenditure and it saves income tax.
The cost of a debenture is relatively lower than preference shares and equity shares.
Issue if debentures are advantageous during times of inflation.
Interest in debenture is payable even if there is a loss, so debenture holders bear no risk.
Disadvantages of Debenture
Payment of interest on debenture is obligatory and hence it becomes a burden if the company bear a loss.
Debentures are issued to trade on equity but too much dependence on debentures increases the financial risk of the company.
Redemption of debenture involves a larger amount of cash outflow.
During a depression, the profit of the company goes on declining and it becomes difficult for the company to pay interest.