In this article we will discuss about the accounting entries for issue of debentures.
(A) Issue of Debenture for Cash:
The issue procedure with regard to debentures is the same as that of shares. The amount due on debentures may be paid in installments, such as, Application, Allotment and Calls. When debentures are issued at premium, the amount of premium is credited to Debenture Premium Account. Debenture Premium Account is a capital profit and is transferred to Capital Reserve Account.
When debentures are issued at discount, the amount of discount is debited to ‘Discount on Issue of Debentures Account. The amount of discount should be shown on the asset side of the Balance Sheet, under the head ‘Miscellaneous Expenditure, until written off.
Illustration 1 (Issue of Debentures at Par):
A company issued 1,000 10% debentures of Rs 100 each at par, payable Rs 40 on application and the balance on allotment. The public applied for 800 debentures. These applications were accepted. All moneys were received. Give journal entries.
Illustration 2 (Issue of Debentures at Premium):
A company issued 10,000 9% Debentures of Rs. 100 each at a premium of Rs. 5, payable as follows:
On application Rs. 40 (including premium)
On allotment Rs. 65
All the Debentures were subscribed for and the money was duly received. Pass necessary journal entries.
Illustration 3 (Issue of Debentures at Discount):
A company issued 5,000 13% Debentures of Rs. 100 each at a discount of 10% payable Rs. 25 on application. Rs. 40 on allotment and Rs. 25 on first and final call account. The debentures were fully subscribed and the money due duly received.
(B) Issue of Debentures for Consideration other than Cash:
X Ltd. acquired assets of Rs. 5,00,000 and took over the liabilities amounted to Rs. 50,000 at an agreed value of Rs. 4,00,000 of Y Ltd., issued 12% Debentures at a discount of 20% in full satisfaction of the purchase price. Show the entries.
Prem Ltd. purchased assets from Ram Ltd. for a book value of Rs 1, 00,000 and liabilities worth Rs. 15,000 for a purchase consideration of Rs. 90,000. The two companies agreed to settle the purchase consideration by issue of 13% debentures of Rs. 100 each.
Pass necessary journal entries in the books of Prem Ltd assuming that:
(a) Debentures are issued at par.
(b) Debentures are issued at 20% discount.
(c) Debentures are issued at 25% Premium.
C. Issue of Debenture as Collateral Security:
A Company can issue debentures to serve as collateral security for a loan or for Bank Overdraft. A collateral security can be realised by its possessor if the original loan is not paid on the due date. Such Debentures are by nature a contingent liability against the issuing Company though they become a definite liability in the event of the breach of the agreement. The holder of such Debenture is not entitled to any interest. On the payment of the concerned loan, such Debenture reverts back to the Company.
There are two ways to deal such issue of Debenture in the books of accounts:
(A) No entry need be made in the books of accounts. However, a note is made in the Balance Sheet. For instance, Indian Limited secures an overdraft for Rs 1, 00,000 from the Bank by depositing Debentures worth Rs 1, 50,000 as collateral security.
This will appear in the Balance Sheet as follows:
Discount on Debentures:
The loss on issue of Debentures – Discount on Issue of Debentures or Premium Payable on Redemption – appears in the Balance Sheet. This is because they are losses – treated as Capital Losses. It is a fictitious asset which must be written off as early as possible.
There are two methods by which the loss or discount on issue of Debenture Account is to be written off:
(a) Equal Annual Writing off of Debenture Discount:
When debentures are to be redeemed after a fixed period, say 5 years, then the amount of discount on issue of debentures can be transferred to Profit and Loss Account by equal instalments. For example, a Company issued 1,000 Debentures of Rs 100 each at a discount of Rs 2,000. Then the amount of discount to be transferred to Profit and Loss Account is Rs 400 i.e. 2,000/5.
(b) Writing off the Discount when Debentures are Paid Back by Instalments:
When the debentures are repaid by instalments, the amount to be written off each year should be in proportion to the amount outstanding against debentures.
That is, the amount to be debited to Profit and Loss Account on the basis of calculation, based on outstanding debentures:
A Company issued Rs 1, 00,000 10% Debentures at 96%. The terms of issue provide the repayment of the debentures at the end of 5th year. Show the amount of discount that should be written off in each of the five years.
Rs. 800 to be written off against Profit and Loss Account i.e. equal annual instalments. This is because each year has the benefit of the whole of the debentures.
Terms of Issue of Debentures:
Debentures may be issued at par, at premium or at a discount. Further, the repayment of the Debentures i.e. its redemption may also be at par or at premium. The loss arising on account of the liability of premium payable on redemption is of the same nature as discount allowed at the time of issue.
The loss on account of premium payable on redemption should also be written off over the life time of the debenture and should be computed precisely the same way as the provision for writing off the discount. Debentures are issued with certain conditions at which redemption can be made. Conditions of redemption will be coupled with the conditions of issue.
Such terms and their journal entries are given below:
A Company issued Rs 5, 00,000 12% Debentures at 94%. The terms of the issue include the repayment of the debentures in five equal instalments beginning with the end of the first year of issue. Show the amount of discount that should be equitably written off in each of the five years.
Discount on Debenture represents a loss of capital nature. It may not be possible to write off the entire loss against the Profit and Loss Account in the year in which the discount is allowed. As such the amount of discount is written off gradually over a number of years against Profit and Loss Account i.e. distributable profits. By doing so, the reported profits can be reduced otherwise it would be appropriated for dividend to shareholders and by the way, the cash can also be retained in the business.
The following illustrations explain the various possibilities:
Discount on Issue of Debenture is a capital loss and should be written off over a number of years against the Profit and Loss Account and in the meantime, it should be shown in the Balance Sheet to the extent not written off. Debentures are credited with the face value at the time of issue and the calculation of interest is always with reference to the face value.
Journalise the following transactions and also show how they appear in Balance Sheets:
(a) A Ltd. issued 5,000 10% Debentures of Rs. 100 each at a discount of 5% and redeemable at the end of 5 years at par.
(b) B Ltd. issued 5,000 12% Debentures of Rs. 100 each at par and redeemable at the end of 5 years at a premium of 5%.
(c) C Ltd. issued 5,000 14% Debentures of Rs. 100 at a discount of 5% and redeemable at the end of 5 years at a premium of 5%.