Accounting for Company - II

According to Section 2(30) of the Companies Act, 2013, a "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. It is an acknowledgment of debt issued by a company under its common seal (or signed by two directors / authorized key managerial personnel) containing an undertaking to repay the specified principal sum at maturity and pay interest at a fixed coupon rate at specified intervals.

• Acknowledgment of Debt: A debenture is written documentary proof that the company owes a specific sum of borrowed money to the debentureholder.
• Fixed Rate of Interest: Carries a prefixed coupon rate (e.g., 9% Debentures), payable periodically irrespective of whether the company earns profit or incurs a loss.
• Charge on Corporate Assets: Debentures are generally secured by a fixed charge (on specific assets like land and machinery) or a floating charge (on general circulating assets like stock and debtors).
• No Voting Rights: Under Section 71(2) of the Companies Act 2013, no company can issue any debentures carrying voting rights. Debentureholders are creditors, not proprietors.
• Debenture Trust Deed: Under Section 71(5), when a company issues a prospectus or invites the public or its members exceeding 500 to subscribe to debentures, it must appoint one or more Debenture Trustees and execute a trust deed before issuing the offer.

• From the Viewpoint of Security:
  • Secured / Mortgage Debentures: Secured by a mortgage or charge on the company's assets. Under Rule 18(1), the date of redemption of secured debentures cannot exceed 10 years (or 30 years for infrastructure companies).
  • Unsecured / Naked Debentures: Carry no charge on any corporate assets. Holders rank as ordinary unsecured creditors.
• From the Viewpoint of Tenure:
  • Redeemable Debentures: Repayable upon the expiry of a specified period or in installments.
  • Irredeemable / Perpetual Debentures: Not repayable during the lifetime of the company except on winding up. Under Indian Companies Act 2013, companies cannot issue perpetual debentures.
• From the Viewpoint of Convertibility:
  • Convertible Debentures: Convertible into equity shares or new debentures at the option of the holder or company. Can be Fully Convertible (FCD) or Partly Convertible (PCD).
  • Non-Convertible Debentures (NCD): Do not carry any option for conversion into shares and are repaid in cash at maturity.
• From the Viewpoint of Registration:
  • Registered Debentures: Recorded in the Register of Debentureholders. Interest warrants are payable only to registered holders. Transfer requires a formal transfer deed.
  • Bearer Debentures: Payable to the bearer. Negotiable instruments transferable by mere delivery. Interest is paid against presentation of detached coupons.

Debentures may be issued by a company: (a) for cash, (b) for consideration other than cash, or (c) as collateral security for bank borrowings.

Debentures can be issued at Par (Face Value = Issue Price), at a Premium (Issue Price > Face Value), or at a Discount (Issue Price < Face Value). Section 53 of the Companies Act 2013 prohibits issue of shares at discount, but this prohibition does not apply to debentures.

• Application Money Received: Bank A/c Dr. To Debenture Application & Allotment A/c
• Allotment at Par: Debenture Application & Allotment A/c Dr. To % Debentures A/c
• Allotment at Premium: Debenture Application & Allotment A/c Dr. To % Debentures A/c To Securities Premium A/c
• Allotment at Discount: Debenture Application & Allotment A/c Dr., Discount on Issue of Debentures A/c Dr. To % Debentures A/c

When assets or an ongoing business are acquired from a vendor, the agreed purchase consideration can be discharged by issuing debentures.

Business Purchase Rule: When Net Assets ( $$\text{Total Assets} - \text{Total Liabilities}$$ ) do not equal Purchase Consideration:

• If Purchase Consideration > Net Assets: Debit Goodwill Account (excess payment for corporate reputation).
• If Purchase Consideration < Net Assets: Credit Capital Reserve Account (capital gain on acquisition).

"Collateral Security" means secondary or subsidiary security deposited with a lender (bank) in addition to the principal security (such as mortgage of building). If the company fails to pay the loan and interest, the lender can first realize the principal security. If the proceeds are insufficient, the lender can enforce rights as a debentureholder.

Under the Prudence (Conservatism) Convention of accounting, any anticipated future loss on the redemption of debentures (such as paying a premium on redemption) must be provided for at the date of issuance itself. Conversely, any prospective gain on redemption is ignored until realized.

• Premium on Redemption of Debentures: This is a personal liability account representing the extra obligation payable in the future. In the Balance Sheet (Schedule III, Part I), it is shown under Non-Current Liabilities under the sub-head "Other Long-Term Liabilities".
• Loss on Issue of Debentures: Combines discount allowed on issue and premium payable on redemption. Under Section 52(2) of the Companies Act 2013 and AS-16, Loss on Issue of Debentures is written off in the year of issue itself according to the following strict priority:
  1. First, against Securities Premium Account (if available).
  2. Balance (if any), against Statement of Profit and Loss (under Finance Costs).
  Securities Premium A/c Dr.
Statement of Profit and Loss Dr.
    To Loss on Issue of Debentures A/c

Interest on debentures is a mandatory charge against profits. The company must pay interest periodically (generally half-yearly on 30th September and 31st March) irrespective of whether it incurs operating losses or earns handsome profits.

• Basis of Calculation: Interest is always calculated on the Nominal / Face Value of debentures, regardless of whether debentures were issued at par, premium, or discount.
• Tax Deducted at Source (TDS): Under the Income Tax Act 1961, companies are legally required to deduct tax at source (e.g., 10%) from the gross interest payable to debentureholders and deposit it with the Central Government credit.
• Charge, Not Appropriation: Being a financial charge, interest is debited to Statement of Profit and Loss under the line-item Finance Costs.

Redemption of debentures implies discharging the liability on account of debentures by repaying the principal sum to debentureholders. To safeguard creditor interests and maintain financial liquidity, the Ministry of Corporate Affairs (MCA) enacted stringent provisions under Section 71(4) of the Companies Act, 2013 read with Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014 (amended in 2019).

• Creation of DRR: Must be set aside before redemption commences.
  Surplus in Statement of Profit and Loss A/c Dr.
    To Debenture Redemption Reserve (DRR) A/c
• Transfer to General Reserve upon Completion: Once all debentures are completely redeemed, the DRR balance serves no further statutory purpose and is transferred to General Reserve:
  Debenture Redemption Reserve (DRR) A/c Dr.
    To General Reserve A/c

Under Rule 18(7)(c), every company required to create DRR (and listed companies other than AIFIs/Banks) must, on or before the 30th day of April in each year, invest or deposit a sum which shall not be less than 15% of the nominal amount of debentures maturing during the year ending on 31st March of the next year in specified liquid assets (e.g., deposits with scheduled banks, Central/State Government securities).

• When Investment is Made (on or before April 30):
  Debenture Redemption Investment (DRI) A/c Dr.
    To Bank A/c
• When Investment is Encashed prior to Redemption:
  Bank A/c Dr.
    To Debenture Redemption Investment (DRI) A/c
    To Interest Earned on DRI A/c (if interest received)

A company may redeem its debentures through four established methods permitted by law and the terms of the debenture trust deed:

The company repays the entire debenture debt in a single payment at the expiry of the stipulated term (e.g., 5 or 7 years). Can be redeemed out of capital (subject to DRR/DRI) or purely out of divisible profits.

• Amount Due to Debentureholders:
  % Debentures A/c Dr. [Nominal Value]
Premium on Redemption of Debentures A/c Dr. [If redeemable at premium]
    To Debentureholders A/c
• Discharge by Bank:
  Debentureholders A/c Dr. To Bank A/c

A predetermined portion of debentures is redeemed every year. Lots are drawn to select the specific debenture numbers to be repaid. The accounting entries are identical to lump-sum redemption for the amount drawn each year.

When permitted by its Articles of Association, a company may purchase its own debentures from the stock exchange. This is advantageous when debentures trade at a discount below face value.

Debentures are discharged by issuing new equity shares, preference shares, or new debentures to the holders.

• Step 1: % Debentures A/c Dr. [Nominal], Premium on Redemption A/c Dr. [if any] To Debentureholders A/c
• Step 2 (Conversion at Par): Debentureholders A/c Dr. To Equity Share Capital A/c
• Step 3 (Conversion at Premium): Debentureholders A/c Dr. To Equity Share Capital A/c To Securities Premium A/c